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Federal Funds Rate: Stocks or Bonds

Posted by kdadmin on September 16th, 2015.

Federal Funds Rate: Stocks or Bonds

Tomorrow afternoon the Federal Reserve will announce their decision about the Federal Funds Rate. Either way, expect a LOT of volatility. Look at the chart above. Notice how the US Unemployment Rate and US Core Inflation Rate are right about where they were before the 2008-2009 crash? That was the Fed’s goal.

Buying into this market is a tough call. Here’s why …

  1. If the Fed DOES raise interest rates:
    1. Stocks will almost certainly go down.
    2. Bonds will likely go down as well, since their price is inversely related to interest rates changes. In other words, if the rate goes up, the bond prices go down.
  2. If the Fed does NOT raise interest rates:
    1. Stocks will almost certainly go up, but it will not likely be long lived, as the October earnings season is right around the corner, and the market is at egregiously high PE levels. See my blog series on that here:Stock Market Warnings.
    2. Some bonds will likely go up, but at a slower rate than stocks will go down. Other bonds will be flat.

Think of tomorrow as the “1” in a “1 – 2” punch scenario. The October earnings season could be the “2” in this scenario. Just because we’ll get through the Fed announcement, doesn’t mean the markets are in the clear yet. Here’s why:

  1. If October earnings reports are POOR:
    1. Stocks will almost certainly go down further.
    2. Bonds may start to tick back up (as investors rush to safety), depending up on their yield and duration.
  2. If October earnings reports are STELLAR (not just good, mind you):
    1. Stocks will almost certainly go up, but without Fed stimulus, there is really nothing to push them over their all time highs of earlier this year. Again, see my blog series on that here:Stock Market Warnings.
    2. High yield bonds will likely go up, but plateau like they did earlier this year. Treasury yields will probably continue to surge wildly and broader market bonds will likely plod along at their current yields.

Great investment management requires not only understanding the economic levers at work in the economy, but also knowing exactly how various asset classes react to changes in those levers. Sometimes, these announcements mandate immediate action. Sometimes, not. Further, economic levers are only half the battle. You must know how to pick just the right investment for the economic lever at hand. Not all funds, or ETF’s, are created equal.

If you’re my client, I will be making the necessary changes to your investment accounts, or giving you specific instructions for assets held at other institutions. If you’re not my client, I guess, “You’ve got to ask yourself one question. Do I feel lucky?

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