Things to watch: Volatility, The Fed, Inflation and the Dollar

Art Haws | NBJ Guest Column | March 3, 2016

The recent volatility proves that global markets are adjusting and correcting on an almost minute-by-minute basis, and as we know from experience, the U.S. economy is increasingly subject to global activity.

Here are a few things that U.S. investors need to watch in the wake of this volatility:

In December, the Federal Reserve raised the federal funds rate by .25, which is the first hike since June of 2006. The rate went to zero in December 2008 and stayed there until December 2015. Although markets have been challenging to say the least coming into 2016, Janet Yellen indicates that the Fed expects to continue modest increases in the fed funds rate. Gradual increases can be beneficial for equity markets as it indicates confidence from the Fed.

The hope is to maintain what is known as a normal yield curve. This indicates that short-term debt yields remain lower than long-term yields. Essentially, the curve tracks U.S Treasuries yields by maturity which can range from three months to 30 years. If the Fed can continue to raise short-term rates and market forces move longer term yields higher as well, that will signify an increasingly healthy economy and usually creates positive opportunities for investors.

An inverted yield curve means that short-term debt yields are higher than long-term yields. This is not a good situation and typically means that some form of recession is looming anywhere from six to 12 months out. Not always, of course, but it does have historical credibility.

Another thing to monitor is an unexpected spike in inflation. Those who were working in the late ’70s and early ’80s will recall the tumultuous economic climate overseen by Paul Volcker who served as the Chairman of the Federal Reserve. A rapid increase of inflation — particularly wage inflation — would force the Fed to raise short-term rates faster and in larger increments which would most likely hurt stocks and bonds.

Finally, the rate hike could lead to continued strength in the U.S. dollar which makes our goods and services more expensive for outside investors. Good for importers. Conversely, a strong dollar can challenge U.S. exporters. Considering our currency’s strong global position, now may be a good time to research foreign investment opportunities.

The rate hike is an overall positive development as it relates to the U.S. Economy. It will require consistent monitoring and attention, but more than anything, it demonstrates our country’s resilience in tough times, and our economy’s ability to regain a dominant global position.

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