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The second FOMC meeting of 2017 will take place next week from March 14-15. And this meeting will have a major impact on some of your valuable investments.
With the inflation rate at a five-year high of 2.5% and the labor market growing stronger, economists across the board believe an interest rate hike is all but certain next week. CME Group reports a 90% probability of a Fed rate hike next week.
A rise in interest rates can have a huge impact on your money. Because the economy is intrinsically tethered to interest rates, most types of investments are also tied closely to them. After all, higher interest rates result in more expensive loans. That causes people to have less money to spend on personal investing.
Here’s how the FOMC meeting could influence three of the most popular types of investments if the Fed decides to raise interest rates…
How the March FOMC Meeting Will Affect Stocks
High interest rates don’t have a fundamental impact on the stock market. But they can have a dramatic impact on the investors and traders who buy and sell stocks.
A prime example is the two-month period following the December 2015 rate hike. On Dec. 16, 2015, the U.S. Federal Reserve raised interest rates for the first time in 10 years. The rate hike caused investors to panic, which led to an 8.3% plunge in the Dow Jones Industrial Average from Jan. 1, 2016, to Feb. 12, 2016.
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But on a long-term scale, high interest rate environments have historically been a boon for stock prices. When interest rates were at an all-time high of 20% in 1980, the S&P 500 saw an annual return of more than 20%.
Here’s how the S&P 500 and interest rates have trended since 1970…
This trend of market rallies has been especially true in the wake of the most recent rate hike on Dec. 14, 2016. Since then, both the S&P 500 and Dow Jones have rallied 4.3% and 5%. While that’s largely due to Trump’s proposed business deregulation and tax cuts, higher interest rates signal economic growth. That positive sentiment can attract investors who want to bet on the economy to the stock market.
Even if there’s volatility after a rate hike on March 15, stocks could see long-term gains from higher rates.
But this next investment has a much more direct relationship to interest rates. That’s because the government can manipulate the price of these investments when interest rates rise…
How the March FOMC Meeting Will Affect Government Bonds
Government or Treasury bonds are issued by the government to finance debt. When investors buy them, they’re essentially loaning money to the U.S. government, which guarantees to fully pay them back with interest. Bonds are considered a safe-haven investment because they provide consistent streams of income when the stock market is volatile.
However, Treasury bond prices have an inverse relationship with interest rates. Bond prices decline when interest rates increase – and vice versa. That means a rate hike next week could drag Treasury bond prices lower.
Their inverse relationship comes from increased bond issuance. When interest rates are higher, the government issues more bonds at a faster rate. This higher supply of bonds lowers demand, which reduces bond prices. That shows in the roughly 3% drop in the Treasury bond price since the last rate hike on Dec. 14, 2016.
Bond prices also move inversely to bond yields. That inverse relationship depends on how confident investors are.
High investor confidence lowers the Treasury bond price and raises the yield because investors think they can find better investments. In other words, they’d rather invest in more profitable assets like stocks rather than safe havens like bonds.
Conversely, low investor confidence attracts more investors to bonds. That pushes the bond price higher and drags the yield lower since there’s more demand for this safe investment.
If the Fed hikes rates next week, bond prices could decline while yields increase. That makes bonds highly susceptible to an interest rate hike at the March FOMC meeting.
Here’s another safe-haven investment that could see big price movement next week…
How the March FOMC Meeting Will Affect Gold Prices
Similar to bonds, gold is a safe-haven investment used as a long-term hedge against market volatility. But a Fed rate hike could have a bearish short-term effect on gold prices since higher interest rates typically boost the value of the dollar
That’s because a surging dollar makes dollar-denominated commodities like gold more expensive to users of other currencies, thus lowering demand and prices. During the fourth quarter of 2016, the gold price declined more than 12% as the dollar surged 7.1%.
But history has shown that long-term gold prices can skyrocket through eras of high interest rates…
During the 1970s, interest rates were consistently above 5% — far above the current 0.5% to 0.75% rate. You’d think gold prices crashed during this decade, but they actually soared over those years. By 1980, gold was 24 times more expensive than it was in 1970.
Although the 0.25% rate hike last December pushed the dollar higher, that effect will eventually wear off. Regardless, gold prices could rally through any high interest rate environment we’re about to enter.
The Bottom Line: The looming rate hike next week has investors wondering how it will affect their money and investments. While it may have a short-term negative impact on stocks, bonds, and gold, all three asset classes are poised for long-term gains.
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