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Why a Fed rate hike tom is so feared

In Currencies, Economy, ETFs on 16/09/2015 at 10:27 am

The rise in inter-bank rates (which impacts mortgage rates) here is part of the chain effect of fear of a Fed hike. The mkt believes that there is a 28% chance that the Fed rate will go up i.e, 70%8 believes it won’t be raised tom. So if it goes up and markets tank read this

Why financial markets are nervous about Fed’s decision tom (from NYT Dealbook).

INVESTORS HOPE FOR SMALL RIPPLES AHEAD OF FED RATE DECISION On Thursday, the Federal Reserve could increase interest rates for the first time in more than nine years. It may still hold after a violent downturn in global stock markets last month, but this moment has long been dreaded on Wall Street, and investors are hoping it won’t unleash too much turmoil, Peter Eavis writes in DealBook.

History shows that booms financed with cheap money often leave the financial system weaker, not stronger, and the fault lines become obvious when the Fed starts to tighten monetary policy.

In theory, a small increase in interest rates should not be enough to wreak havoc, but some analysts have a darker view of the weak links in the system. They say financial markets have funneled trillions of dollars intoinvestments that will prove unsustainable when interest rates go up.

And the signs of excess are everywhere. Technology companies have been able to raise huge sums even before they tap into the public markets. Debt markets have appeared overly eager to lend. Low interest rates mean investors more willing to buy stocks at historically high valuations and companies are able to borrow money cheaply to buy back their own shares and bolster earnings.

Doomsayers think these activities have continued for so long that companies are more vulnerable to a slight increase in interest rates.

However, even gloomier analysts have predicted a great reckoning for years and it has not yet happened, Mr. Eavis notes. The new restraints on Wall Street and the housing market have so far prevented a resurgence in the toxic real estate lending that occurred a decade ago.

Corporations’ borrowing costs are no cheaper when accounting for inflation. Since the end of 2008, the average, inflation-adjusted yield on corporate bonds of moderate credit risk has been 4.1 percent, compared with 3.94 percent for most of the postwar period.

The Fed’s policies also appear to have prompted a surge in lending that is more stable than the securities markets under higher interest rates. Buybacks are not certain to become less attractive, but if they do, it might prompt executives to invest spare capital in operations in an effort to increase productivity.

Yet fears about the markets themselves remain. High-frequency trading has ballooned over the last decade. Firms using automated trading account for about half of all trades in the market for Treasury Securities. Exchange-traded funds are a major force in the stock market.

E.T.F.s, whose shares are supposed to be closely tied to the value of their underlying assets, have created concerns recently. On Aug. 24, shares in some funds briefly fell to prices well below the value that they would have commanded had they stayed in line with the fund’s underlying holdings. An investor selling at that discount might take an unnecessary loss.

If heavy selling is widespread across many markets, the smooth functioning of these products and markets may be tested.

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