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Should Investors Pounce On Yellen’s Rate Hike Hint?

By Nicholas Kitonyi
Published on: 14:55 PST, May 29, 2016

On Friday, the Federal Reserve chair Janet Yellen hinted that the committee could increase interest rates again in the coming months.

When answering a question directed to her during a press conference at Harvard’s Radcliffe Institute for Advanced Study, Yellen said the following.

“It’s appropriate, and I’ve said this in the past, I think for the Fed to gradually and cautiously increase our overnight interest rate over time and probably in the coming months, such a move would be appropriate.”

The Federal Reserve increased interest rates for the first time since the global financial crises of 2008 in December of last year. However, since then, things have not been as smooth as expected post the exercise and now, market analysts have been coy on advising on when would be the ideal date for another rate hike.

Some fear that a continuous increase could have a devastating effect on economies that are going through tough times like the Eurozone, which could eventually have a trickle effect on the rest of the world, including the U.S.

For instance, following the December rate hike last year, Nick Kounis, the head of macro and financial markets research at ABN Amro, told the Financial Times that “The most important effect [of the Fed’s rate rises] will be a lower euro/dollar exchange rate, which should push up import prices and hence lead to some upwards pressure on inflation.” This would make the already bad situation in the Eurozone worse.

In addition, the Federal Reserve has also exercised caution in providing information to the market with regard to U.S. economic growth and stability. Even in Yellen’s most recent comment on economy and interest rate hike, she maintained that the process will be gradual and cautious.

Nonetheless, the recent remarks from the Fed chair are a strong indication that a second interest rate hike could be coming as early as next month, or probably in July. This could also imply that a third interest rate hike could be on the way before the end of the year.

Now, currently, the base U.S. interest rate is pegged at 0.50 percent up from 0.25 percent before the December increase. Two more increases by the end of the year by the same basis points could see the rate hit 1 percent. Ideally, this level of interest rate would need a strong backing from the economy in order to sustain growth.

Janet Yellen has maintained caution in basically all her remarks on the economy saying that a rapid increase in interest rates could gag the current progress, especially if inflation does not measure up to the projected levels.

So far, it is fair to say that the economic figures received from various departments have demonstrated good signs, which have convinced the Fed that another rate hike wouldn’t be harmful to what has already been achieved.

Now, while various key economic numbers like the unemployment rate, new jobs numbers, as well as the manufacturing output and GDP, have continued to improve, the threat posed by the slowdown in global economies cannot be ignored.

The measure between the global economic status and the U.S. economy’s ability to withstand any slowdown in countries like China, Japan, and the Eurozone has been one of the most discussed issues in the market.

Some analysts believe that while a rate hike would make investing in income assets more compelling, it could also be a deadly trap should the U.S. economy fail the test. For instance, following the December rate hike, especially in January, the stock market plunged across the board whereas commodities like Gold surged upwards.

This demonstrated some level of fear of investing in stocks as investors switched some of their capital to investing in gold. Gold is considered a safe haven for the value of money, especially during unpredictable economic times. The market has recovered since late January, but even so, analysts remain coy on what has so far been one of the most volatile periods in the stock market for years.

Therefore, as the Federal Reserve prepares to announce what would be another interest rate hike in the coming months, it would be advisable to reconsider the decision on whether or not to gamble on Janet Yellen’s hint.

[Photo by Charles Krupa/AP Images]

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