US rate hike . So what?
Finally, since June 2006, US interest rate has gone up again. Fed Rate has gone up by 0.25% to a range of 0.25 to 0.5%. So why did US Fed increase interest rate in Decembere? There is no perfect timing and perhaps the Fed missed a better slot earlier. Like before the China A shares bubble burst in July. The tension between the European Union and Russia over Ukarine, the Syria rufugees and the unhealing Greek situation have nailed Euro to the floor. Commodities currenies such as Canadian Dollars and Australian Dollars fell as China economic slowed down. China Renmanbi also joined the dark side to depreciate its currency to ease the downward pressure in property and stock market.
Another angle is that the purpose of loosening in monetary policy and dropping interest rate to zero was to save the US finanicial industry. The AIG, Fannie Mae and Frediie Mac, Citibank and other financial institutions that were paralized from the shock of Lehman bankrupcy. Now these Financial Institutions have regained strength and the US Fed can increasae rate. Increase interest rate is like sending US economy to the gym for training. Make the economy sweats, gets fit and builds muscle and prepare for the next bubble bursting. US companies can take advantage of the US Dollar strength to do acquisition. Many foreign markets and currencies have fallen against US Dollar. It could be shopping time.
Bond market would suffer especially bonds with fixed coupon. As interest rate goes up, these bond prices tend to drop. The longer the maturity of the bonds, the more they could drop in prices. The currency market is harder to read as USD is already so strong. Long USD short EUR is an attractive carry trade. Banks charge clients to deposit EUR and pays clients interest on their USD deposit. Would EUR drops to less than a USD? Many institutions have shorted EUR agasint USD and rode the long term trend. Many hedge fund managers and currency traders who short EUR with high leverage got burnt from wrong timing as EUR could rebound fiercely. For those who are non professional but have a strong conviction in the currency market, lower or no leveage position could help you to ride the longer trend and withstand sharp market movement. Leverage or margain trading are definitley high risk investment as the investors could lose more money than they put up in the first place, leading to debt beyond affordability.
For stock investors who feel EUR will be further weakened against USD, companies that are EUR sensitive could be interesting. For example, international airlines that have most of the cost in EUR but getting revenue in USD. Similarly tourism sector, luxury goods, engineering companies and manufacturers. Eurostoxx 50 Index ETF or the German DAX Index ETF are convenient investment tools to get exposure to the Euro zone story. However, the increased compeitiveness due to a weak Euro is offset by many risk factors. The Euro zone is a live case study of a system that is facing all the uncontrollable risks at a corporate level. Currency unpeg, political risk, war, terrorist attack and social unrest are all real risks in the Euro zone. Buyers beware.
There are 2 other economies that could potentially continue their growth in a rising US interest rate environment. UK is likely to enjoy its physical separation as an island from the rest of Europe and its independency in Great British Pound. UK global software and IT sectors are competitive. Education sector is a real GDP contributor and the growing population in oversea university students drives rental market nearby and supports property prices. UK economic grwoth is expected to be around 2.9% in 2015 and it is the second fastest in the advanced world after USA. UK economy is expected to be 6.1%I larger than its peak before the financial crisis. Ireland is the only English speaking country in Europe using EUR. Its GDP rose by 7% in the first half of 2015, probably the fastest in the Euro zone after surpassing the pre-crisis high last year. Its low corporate tax rate of 12.5% attracts phamaceutical companies like Pfizer and tech companies like Apple, Google and Facebook to setup European base.
