Wall Street is abuzz with talk the Federal Reserve will hike interest rates today.
Chairwoman Janet Yellen is expected to announce a rate hike today at the conclusion of the Fed’s two-day meeting.
The move is one of several factors influencing the U.S. financial markets. Former Federal Reserve Chair Alan Greenspan sees bond yields climbing to 5 percent, adding that we are in the early phase of a major inflation jump.
And Dodd-Frank legislation should be repealed, Greenspan added, claiming it is reducing liquidity in the financial system. The law should be replaced with a large equity-to-asset ratio requirement for financial intermediaries.
Interestingly, Greenspan made these observations on Nov. 7, or one day before Donald Trump won a stunning presidential election upset. Almost immediately, key mortgage rates rose.
While some may call Greenspan prescient, more advisors are likely left wondering how high rates will go, and how far a Trump administration will go in loosening Dodd-Frank and financial insurance government regulations in general.
“Greenspan is spot on,” said Michael Lee, founder of Tiger Wealth Management in Darien, Conn. “Inflation is coming back, and bond yields are going higher. If Dodd-Frank can be repealed or reworked so that the monetary supply can be expanded while rates rise, we are off to a new era of growth in the U.S.”
Can Markets Go Higher?
Given that scenario, clients may well ask their advisors in the coming weeks whether or not higher rates really can drive equity markets higher.
“Certainly the Dow can keep climbing after a rate hike,” said Robert Johnson, president and CEO at The American College of Financial Services, in Bryn Mawr, Pa.
The biggest factors are economic growth and earnings, he explained.
“If the fiscal stimulus as a result of infrastructure spending and tax cuts stimulate the economy, then we could continue to see growth in the Dow,” he said. “However, once rates and bond yields start to rise, there is likely to be a rotation from equities and into bonds, which will put price pressure on equities."
In recent years, many yield-conscious investors have eschewed the bond markets, choosing instead to invest in high-dividend yield stocks, Johnson noted. As bond yields rise, these high-dividend yield stocks become less attractive.
Still, not everyone sees the financial markets expanding early in a Trump presidency. The Dow Jones has risen from 18,250 on Nov. 7 to nearly 20,000 entering today.
“In the past six years, we have seen interest rates rise by at least 85 basis points four times (late 2010, mid 2013, early 2015, and now),” said Gene Tannuzzo, portfolio manager of the Columbia Strategic Income Fund.
The first three increases were followed by a slowdown in economic growth, weakness in the housing market, and subsequent dovish surprise from the Federal Reserve, he said.
“In the current environment, rates have risen by 110 basis points, the U.S. dollar has risen and financial conditions have tightened,” he added. “The economic data over the next few months should begin to reflect this tightening in slower growth.”
Inflation Trends To Watch
A President Trump does not mean the market is immune to normal influences, he said.
“For the past three years, inflation has been trending lower,” Tannuzzo said. “Suddenly, Donald Trump is elected president, and the market is convinced inflation is going to skyrocket? Why?”
Disinflationary pressures are driven by high aggregate debt levels in the economy, an aging labor force with baby boomers retiring, a shift towards a service-based economy, and a strong dollar, he noted.
“Donald Trump's policies may be positive for growth on the margin, but these core forces have not changed,” Tannuzzo said.
But that bearish opinion seems to be in the minority, as most money managers see higher growth ahead for the financial markets.
“At this point the Federal Reserve rate hike is priced in,” said Mark Painter, founder of Everguide Financial Group in Berkeley Heights, N.J.
There is a possibility for some “short-term downward shock” if the dot plot is a little higher than expected, he said, and “you have to account for potential reflation continuing, global GDP accelerating, and corporate earnings growing again.
“That said, there’s been too much emphasis has been put on valuation and interest rates, Painter added. “As long as we do not head to a recession, this market is going higher.”
Brian O'Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC's Guide to Creating Wealth. He's a regular contributor to major media business platforms, including CBS News, The Street.com, and Bloomberg. Brian may be contacted at email@example.com.
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