How investors could benefit from Fed’s tug-of-war on interest rates?

How investors could benefit from Fed’s tug-of-war on interest rates?


 

By Harry Kourouklis

 

Consensus that the Fed won’t dare pull the trigger on interest rates this week has kept markets asleep. This hasn’t allowed interest-sensitive equities to prepare for such a hike, which might not occur now, but could very well be announced as early as September, during the next scheduled Fed meeting. It is clear that Yellen has one too many unknown factors to deal with beyond the September mark, the US elections being the most critical. This means that the Fed is working with a really narrow timeline if it wants markets on its side. If interest rates are expected to rise in a couple of months, then investors are looking at a great investment opportunity today. A synthetic long position on financials, matched with an equally sized short position on defensives, could be the smart-play in advance of this week’s meeting.

 

Fed’s Critical Move

An interest rate hike is certainly something that can be expected from the Fed as it would like to “seal” the end of its last monetary cycle, thus proving that it has succeeded in normalizing the US economy. In fact the recent G20 meeting could act as a prelude to such an occurrence, as G20 nations changed their rhetoric, for the first time, and stressed the need for fiscal policy to accommodate monetary authorities’ efforts. This strategic turn could very well be viewed as creditor nations succumbing to pressures from debtor ones to inject “fiscal steroids” in their economies as a relief to US rate normalization.

The questions therefore is not whether the Fed will employ such a tactic, but rather when it will decide to announce it. While raising interest rates now would perhaps be the most prudent choice as the historically low market volatility/risk premia environment greatly assists markets to absorb such a hike, it still remains a highly unlikely event. This leaves September and December as the only two available slots at the Fed’s disposal. December seems to be a very risky choice since too many factors can overturn the current state of the market. September, therefore, emerges as the most probable time for the Fed to move forward with a rate hike.


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