Last night the Federal Reserve (FED) left the U.S. interest rates unchanged, as widely expected, but stuck with the plan to gradually lift the rates at the next meeting in September. There is now an 80% probability that the rates will change next time round.
In the statement it was highlighted that the US economy is continuing its expansion with a growth rate of 4.1% in the second quarter which is its best in almost four years. Inflation stands now at 2.2% which is very close to the FED’s goal of 2% whilst unemployment is now 4% which is close to full employment.
From a market perspective nothing much changed as equites were mixed by end of day whilst the yield on the 10-year US Treasury touched 3% since June. When central banks adopt a hawkish policy with respect to interest rates, it means that officials are seeing, like in the case of the U.S., that the economy is doing well and in line to their normalisation targets.
On the below chart, we can notice that the FED increased the base rates seven times since the end of 2015 when they started to tighten their policy. Following the financial crises in 2008, the base rate was held at 0.25% for seven years until the first-rate hike back in December 2015 which saw the rate, which now stands at 2%, go up to 0.5%.
One sector which benefits when interest rates increase is the financial sector as banks/financial institutions will charge more in order to lend money. The above chart compares the S&P 500 Financials index, which only includes the 68 financial sector companies in the broader S&P 500 index, with the aforementioned all sector index.
We can notice that since there was the first hike in 2015, the Financials based index recovered the previous post crises levels and managed to beat the generic index over the longer term. Since the first-rate change in 2015, Financials have managed to outperform the broader market by more than 13%.
The trend for rate normalisation is suggested to continue and hence for those who are not yet overweight in this sector it might be a good time to re-balance your portfolios. The S&P 500 Financials can either be traded as a whole or else one can pick one or more from the underlying consituents. The top 10 holdings in this index can be found below:
JP Morgan Chase & Co (JPM)
Berkshire Hathaway B (BRK.B)
Bank of America Corp (BAC)
Wells Fargo & Co (WFC)
Citigroup Inc (C)
Goldman Sachs Group Inc (GS)
US Bancorp (USB)
American Express Co (AXP)
Morgan Stanley (MS)
PNC Finl Services Group (PNC)
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Past performance is not a guide to future results. This information is being provided solely for information purposes and should not be deemed or construed as investment advice, advice concerning particular investments, advice concerning investment decisions, tax or legal advice. Similarly, any views or opinions expressed are not intended and should not be construed as investment, tax and/or legal recommendations or advice. No person should act upon any opinion and/or information in this document without first obtaining professional advice.