A few days ago, one of my committed clients of many years, who happen to be in medical field innocently, asked me this question, “Christopher, can you please explain the meaning of this Fed hiking of interest rate, and how should such action affect my portfolio?” It actually dawned on me that many of my clients might have the same need to know the answers to such questions, so I decided to do justice to all my clients and followers at the same time by blogging about this. Now please, do not blame me if you cannot invest about ten minutes to read it to the end.
Trying to explain increases and decreases in federal funds rate (interest rate at which banks trade balances held at Federal Reserve with each other, usually overnight; banks with surplus lends to banks with deficit funds) and the immediate impacts in general interest rates without mentioning the expansions and contractions in the overall economy might seem like, ‘a biology teacher trying to teach a bunch of 13 year old kids about life, without touching sexual organs’. I figured, the only way my client would understand this fed fund rate, might be to go deeper and give him more than he requested for, so I said, “here is the process; we talk about economic boom, recession, before we get to fed fund rate”; he proceeded to say “Christopher, you know you love to write, “Can you please give it to me in print?” I said, consider it done. So here we go, econs122015;
Economic boom, can be defined as a period of extended economic expansions, where most people that are willing to work will be gainfully employed, productivity will go up, stock market, other business activities, rents, school fees, wages and etc. will also go up at the same time. Interest rates (cost of borrowing from banks), inflation (basket prices of goods and services) will gradually be rising. The United States economic boom of the 1990s was orchestrated by the growth in ‘internet’, President Clinton’s fiscal policy, Alan Greenspan monetary policy (cutting interest rate to a record low), and some financial crises in the world Asia in 1997 and Russia in 1998 (making US investment more attractive), all combined to give the economy almost a decade of solid and sustainable economic growth.
A monetary policy of aggressive cutting of interest rate, an expansionary fiscal policy, a game-changing innovation, and minor economic crisis in other parts of the globe village can give any structured and transparent economy a good period of sustainable economic growth. One of the major dangers of economic boom is currency destruction, because if the accelerating growth not quickly managed, and controlled, it could lead to a high inflationary period that can destroy a nation’s currency. Few economic leading indicators like, Consumer Price Index (CPI), Real GDP, Building permits, stock prices (S&P 500 Index), and Real M2, are gradually beginning to inch towards an overheating economy, however, the global financial and geopolitical concerns like Europe migrant crisis, Europe Quantitative Easing, African financial crisis, ISIL, China economic slowdown, Crude oil declining prices, global currency devaluations are standing between Janet Yellen and possibility of an overheated economy. Based on all those global concerns, I am mulishly optimistic that the Federal Reserve Chairlady (Janet Yellen) and the Federal Open Market Committee (FOMC) will most likely not hike interest rate till the first quarter of 2016, but if for any reason they decides to hike interest rate, they risk plunging the global village into a deep recession before the fourth quarter of 2016. The fragility of global quagmires like, the 3 Cs mentioned earlier, China, Crude Oil prices and Currency devaluation, would definitely not be able to absorb US fed interest rate increase at this particular time. Now this is very important because, when Federal Reserve starts to gradually hike interest rate, it is best to stay away from fixed incomes, Treasury bills, bonds etc. Initially, money will flow out from fixed income into Equity, but eventually everything, most assets class would all be plummeting fast, recession nonetheless, will always sets in, sometimes with disguised repeated warnings.
Recession might be defined as the opposite of economic boom, a deflationary period that would see all the air gradually escape from the bloated and over inflated balloon. It is also a period of general economic decline usually signaled by two successive quarters of GDP (Gross Domestic Product) of any nation. Recession might also be defined as basically, an extended contraction from a prolonged economic growth cycle. So anytime there is a boom, it usually followed by a burst; human beings only love to swim in booms and not burst, because burst comes with so much pain. Once the expanded monetary supply in the system has been stretched to a mind boggling point and no more room for adequate growth without ushering high inflation rate, happens where recession sets in, then most of the economic gains, if not well preserved might gradually be blown away by the contracting economic cycle.
Economic boom and recession are both endless continuously repeated business cycles that mankind must truly face on this earth, because these are times, when wealth will exchange hands from some groups of people and companies(unprepared and unfortunates ones) to other groups of people and companies(lucky and prepared ones). You should be able to witness boom followed by a burst in your portfolios. This is a period when you hear stories of few individual investors flying off from their high-rise buildings to early deaths because they felt they have lost so much money. Technically, the actions of booms and bursts bring us to the factual reality on the idiomatic expression in the English dictionary of “one man’s loss in another man’s gain”
Concluding this write-up, I would love to state that, by saying Fed hiking of interest rate is simply to prevent an overheating of an economy that might eventually lead to high inflation rate which would invariably destroy the currency of US. I honestly do not think that Janet Yellen and the FMOC members should hike interest rate anytime soon, because that would lead to further strengthening of the already King Dollar, which will drastically compound US manufacturing sector’s conundrum while at the same time escalating my projected global recession. As a matter of fact, if I am a member of the team, I would put up a strong argument why QE4 (Quantitative Easing 4) should come into play in US monetary policy. I humbly wish that I answered your germane questions to the best of my knowledge, but if you think otherwise, kindly follow it up on my blog page so that others would equally benefit from your honest curiosity.
Remember to make adequate preparations for my predicated 2016 fourth quarter global recession, so that you will not be among the unprepared numbers. Permit me to dedicate this article to Central Bank of Nigeria Governor- Godwin Emefiele and his FOMC members as they work very hard to bring down Nigerian lending rate under low single digit, because that is the only way manufacturing and other business activities will thrive in the country.
Christopher Okoli (A Nigerian-American Investment Advisor) December 3rd 2015