Wednesday, December 16, 2015

Fed's FOMC Announces 0.25% Rate Hike, Stocks Soar On The News, Banks Raise Prime Rate

As expected, the FOMC (Federal Open Markets Committee) raised the interest rate on federal funds (the rate for overnight loans from one financial institution to another from funds held at the Federal Reserve) from a range of 0.00-0.25 to 0.25 to 0.50.

Full release here.

On the surface, this seems much ado about nothing, or, almost nothing, but the Fed's long-awaited rate increase will have ramifications across the investing and business world.

For instance, the first salvo will be to any and all loans tied to the Prime Rate, which include most credit card, revolving debt and home equity loans and lines of credit.

Shortly after the Fed's rate announcement, major banks began announcing that they were raising their prime lending rate from 3.25 percent to 3.50 percent. Wells Fargo was the first bank to announce the rate hike, followed in rapid pace by Chase, Citibank and Bank of America. The increases are effective immediately.

What that means is if you've been paying 4% (not unusual) on a home equity loan, your new rate will be 4.25%. In real terms, on $250,000, that's an additional $37 per month. Not much, one might think, but, considering that the Fed plans on continuing to increase their base FF rate - which will green light the banks to up the prime rate - the cost of borrowing will simply continue to increase.

Many analysts have shied away from calling the Fed's move ill-timed, though an equal number has called it "too late." What it certainly is not is "too little." Insofar as it is the smallest rate hike imaginable, its effects will be far reaching.

In larger, banking terms, try this: A billion dollars borrowed over seven years at 1/4% would cost $12,010,470 per monthly payment. At 1/2%, it's $12,116,790, an increase of $106,000 a month. That same billion, borrowed for just one year at 1/4% interest requires a monthly payment of $83,446,220. At 1/2%, it's 83,559,200, an increase of $112,980 per month.

With numbers like these being thrown around routinely - and daily - by the largest financial institutions, hedge funds, brokerages and their ilk, something is bound to blow up sooner, rather than later. Already we've witnessed carnage in the junk bond markets, which have been pounded in anticipation of today's Fed announcement and there will surely be more to come.

On wall Street, stocks appeared to love the move, with the Dow up 224 points, the S&P gaining 29.66, and the NASDAQ ahead by 75.77. This looks all well and good right out of the box, but there's a quadruple witching day coming up Friday on options, and year end is now within spitting distance.

It might be wise to square up one's positions - if one has any - before the end of 2015 to take advantage of tax breaks for losses and/or long term gains. Precious metals moved rather sharply throughout the day and did not pull back after the Fed announcement, despite the dollar remaining strong, which is the obvious outcome.

For now, the strong dollar will continue to stoke deflation, as imports will become cheaper. To anybody who's been Christmas shopping, the price structure is obviously on the low end this season and will likely be bargain basement after the holiday shopping ends.

Most Americans will find bargains in stores, if they have any money with which to purchase them after paying what are sure to be higher credit card bills.

According to the Federal Reserve, the US economy is supposed to be strong enough now to absorb this rate increase and the associated nuances. At this juncture, it's far too early to tell.

We shall see in coming weeks and months. As Ernest Hemingway so eloquently put it in The Sun Also Rises: "How did you go bankrupt?"

"Two ways. Gradually, then suddenly."

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