Fed hikes interest rates amidst banking crisis. Here's how it could affect your portfolio

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By Beansprout • 23 Mar 2023 • 0 min read

The US Federal Reserve (Fed) has just announced another rate hike of 0.25%. We analyse what this means for your investment portfolio.

Fed rate hike March 2023

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What happened?

The US Federal Reserve (Fed) has just announced another rate hike of 0.25% (25 basis points). 

This would bring the target range of Fed fund rate to 4.75% to 5%, the highest level since September 2007.

The Fed interest rate decision was closely watched as investors were looking for indicators of how the US Central Bank would react to the developing banking crisis, following the collapse of Silicon Valley Bank. 

Let’s take a further look at we learnt from the Fed interest rate hike and what it means for your investment portfolio.

What we learnt from the Fed interest rate hike

#1 – The Fed expects to continue raising interest rates

Fed officials expect interest rates to be at 5.1% by the end of the year, the same as their projections back in December 2022. 

This would mean that we will likely see another rate hike of 0.25% this year, which might disappoint some investors who were already expecting the Fed to pause or even cut interest rates in the March meeting. 

Why is the Fed so persistent in raising interest rates despite the financial market turmoil it has already caused?

Fed Chairman Jerome Powell acknowledged that the process of bringing down inflation still has a long way to go.

He noted that inflation “remains too high” and “the labour market continues to be very tight”.

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#2 – Rate cuts not expected until 2024

Powell made it clear that officials are still not projecting any rate cuts for this year. 

When asked if the Fed would rule out more rate hikes, Powell replied “no, absolutely not”.

However, investors are currently expecting that rate cuts would come through sooner than what the Fed is projecting. 

According to CME FedWatch Tool, most investors are expecting that the Fed funds rate to be at 4.0% to 4.25% in December 2023, lower than the current rate of 4.75% to 5%. 

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Source: CME FedWatch Tool

 

#3 – Fed action made more complicated by banking crisis

Following the collapse of 3 US banks in the past month, there were naturally questions asked about the soundness of the US banking system.

This is something that Fed officials are keeping a close lookout for, as the issues faced by the smaller regional banks can undermine confidence in the larger banks if left unaddressed.

For now, Powell has tried to assure investors that the banking system is “sound and resilient, with strong capital and liquidity”.

However, his comments came through at the same time that Treasury Secretary Janet Yellen spoke at the Senate.

She said that regulators have not considered or discussed a ‘blanket insurance’, or broad increase in deposit insurance to stabilize the US banking system without working with lawmakers. 

“I have not considered or discussed anything having to do with blanket insurance or guarantees of deposits”.

What would Beansprout do?

#1 – Uncertainty ahead. Watch the US banks.

There is still significant uncertainty in the market as investors await the to see how the banking crisis will unfold, and how the Fed and regulators will step in to provide support. 

Powell’s comments that there will unlikely be rate cuts and Yellen’s comments that regulators are not considering ‘blanket’ deposit insurance led to a sharp decline in key stock indices. 

US regional banks were most significantly impacted by the weaker sentiment, with the KBW Nasdaq Bank Index which tracks the performance of leading and regional banks declining by 4.7%.

Morningstar has raised the uncertainty rating on its US regional banks coverage from Medium to High. 

Compared to the regional banks, the larger banks like JP Morgan and Bank of America are expected to experience less volatility on its deposits. 

#2 – Bond yields lower as flight to safety continues

Bond yields fell after Powell’s speech as the flight to safety continued. The US 2 year treasury note fell to below 4.0% from above 4.2%.  The US 10 year treasury yield fell to below 3.5% from above 3.6%.

Recently, we have also seen the cut-off yield on the 6-month Singapore T-bill falling to 3.65% p.a.

Singapore government bond yields have continued to be volatile since then. For example, the 10-year Singapore government bond yield fell to as low as 2.83% on 20 March, before recovering to 2.91% as of 22 March.

The fall in bond yields has led to some banks in Singapore lowering their fixed deposit interest rates in recent weeks. 

However, we were still able to find some fixed deposit accounts that were offering an interest rate of 4.0% p.a. This is above the yield on the latest 6-month T-bill. 

#3 - How to hedge against volatility?

Singapore REITs are typically seen as potential beneficiaries when government bond yields fall, as the dividend yield they offer might appear more attractive to investors.

However, the uncertainty of a sharp economic slowdown might also dim their property leasing prospects. 

REITs with retail assets such as Frasers Centrepoint Trust (FCT), Mapletree Pan Asia Commercial Trust (MPACT) and CapitaLand Integrated Commercial Trust (CICT) are generally seen to be more resilient in a recession. It is also important to look for REITs which have a low level of debt and do not face any refinancing issues. 

Gold is also traditionally seen as a hedge against market volatility. Find out how you can get exposure to gold and diversify your portfolio through gold ETFs. 

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