Financial Report Research

Total Word Count: 1722
   Send article as PDF   

<p align=”center” style=”text-align:center;line-height: 200%”><b>Introduction</b></p>
<p style=”line-height:200%”>Towards the end of 2015, the Federal Reserve Board Chair Janet Yellen announced that I was the right time to adjust and increase the federal rate. The adjustment was the first one since 2006 a year before the economic crisis (Williams, 2016). The Fed had managed to maintain the near-zero interest rate unchanged for over a decade because there was continued lack of inflation rate, lack of hot job markets, as well as the uncertainty that was surrounding the economy of China. However, the Fed felt that the economy was healthy enough to support a higher borrowing cost and during the December 16, 2015, Fed meeting, they made the final decision and increased the interest rate by 0.25% (Fed Raises Key Interest Rate, Citing Strengthening Economy – The New York Times. (n.d.). Many financial analysts and economists anticipated that the interest rate would continue to increase such that towards the end of 2016, the interest rate would have increased to more than 2% but that was not the case. The interest rate remained at the range of 0.25% to 0.5%.</p>
<p align=”center” style=”text-align:center;line-height: 200%”><b>Why Fed Will Increase the Interest Rates</b></p>
<p style=”line-height:200%”>Mid-February 2017, Janet Yellen announced that Fed is likely to increase the interest rate in its preceding meetings this year. One of the factors they were to consider at their March 2017 meeting was whether the rate of employment and inflation are continuing to evolve as they have anticipated and needs further adjustment of the federal fund interest rate. They would use the United States economic data to determine whether the labor market is continuing to strengthen and the inflation rate increasing towards the2% Fed target (Johnson, Jensen &amp; Garcia-Feijoo, 2016). On March 15, 2017, the Fed increased the interest rate by 0.25% such that it ranges between 0.75% to 1%. Janet Yellen promised to stick to their focus of two more increased this year and three increases in 2018 (Fed Raises Key Interest Rate, Citing Strengthening Economy – The New York Times. (n.d.). She explained that the economy was doing well and that is why they had increased the rate. The unemployment rates have declined, and many people are optimistic about their job prospects. Besides, the Fed believes that the inflation rate will continue to increase and give them a reason to further increase the interest rate (Fed Raises Key Interest Rate, Citing Strengthening Economy – The New York Times. (n.d.). The better economic view is reinforced by President Trump&#39;s proposed economic policies which include cutting off the taxes and increase infrastructure and military spending. However, Fed is not certain because they do not know how much of Trump&#39;s proposed policies will be passed by the Congress. Altogether, the current economic conditions suggest possible further advancement to the federal fund rate.</p>
<p align=”center” style=”text-align:center;line-height: 200%”><b>The Impact of the Interest Rate Hike</b></p>
<p style=”line-height:200%”>The interest rate hike is likely to have an impact on the bond market, stock market, mortgage market and the entire economy at large.</p>
<p style=”line-height:200%”>Bond Market</p>
<p style=”line-height:200%”>With the anticipation of interest rate increase at the beginning of March this year, the 30-year Treasury bond was at 3.2% on March 10, 2017. This was close to its month high.</p>
<p style=”line-height:200%”><img alt=”How Would the Fed&amp;#8217;s Interest Rate Hike Impact the Bond Market?” height=”445″ id=”Picture 1″ src=”/wp-content/uploads/2019/10/order-126870_1.jpg” width=”624″ /></p>
<p style=”line-height:200%”>From the above chart, it is evident that the performance of a bond decreases with the increase of the interest rate. Therefore, the bond market will be affected negatively by an increase in federal fund interest rate. The rising interest rate leads to investors monitoring the duration of their bond investment to avoid a significant impact on their return (Williams, 2016). The maturity of a bond allows the investors to measure the sensitivity of a bond to change in the interest rate.</p>
<p style=”line-height:200%”>Stock market</p>
<p style=”line-height:200%”>The interest rate hikes affect the stock market negatively. However, the impact is not a direct one meaning that a hike in the interest rate has a ripple effect on the stock market. In other words, since the importance of increasing the interest rate is to reduce the amount of money supply in the economy, it causes the financial institutions to increase the rate at which they extend credit to their consumers (How Would the Fed&#39;s Interest Rate Hike Impact the Bond Market? – Market Realist. (n.d.). If consumers find it hard to access money in which they can finance their investments which include investing in the stock market.</p>
<p style=”line-height:200%”>Mortgage Market</p>
<p style=”line-height:200%”>The hike in interest rates makes the home buying expensive. Although the Fed does not set the mortgage interest rates, its actions affect the housing market. For instance, the Fed is blamed for causing the 2008 economic crisis that was associated with the housing market. The rate of interest rate increases with increase in the 10-year treasury bond which acts as a benchmark for many forms of credit (How Would the Fed&#39;s Interest Rate Hike Impact the Bond Market? – Market Realist. (n.d.). The interest rate on mortgages has increased since Donald Trump gained power and the anticipations of Fed tightening the monetary interests further.</p>
<p style=”line-height:200%”>Economy in General</p>
<p style=”line-height:200%”>An increase in the interest rate means that the consumers and businesses will have difficulties accessing loans to purchase and plan their investments. This is because the hike causes an increase to the prime rate which represents the credit rate at which banks extend loans to their creditworthy clients (How Would the Fed&#39;s Interest Rate Hike Impact the Bond Market? – Market Realist. (n.d.). A high prime rate means that the bank will increase the fixed charges as well as the variable rate borrowing costs while assessing their creditworthy consumers. On the other hand, credit card rates are also affected making it expensive to access cheap short term credit. Finally, interest rate hikes boost the cost of borrowing for the US thus increasing the US public debt. There will be less money supply in the economy since the increase of interest rate is a contractionary monetary policy tool that curbs the rate of inflation by reducing the amount of money supply in the economy.</p>
<p style=”line-height:200%”><b>The Impacts of Interest Rate Hike on The Profitability of Financial Institutions</b></p>
<p style=”line-height:200%”>The federal fund rate hike anticipated to continue during the year will increase the profitability of financial institutions such as the commercial banks, investment companies, insurance companies as well as the mutual fund. Such companies tend to have huge cash caused by the customer balances and business activities. The increase in federal fund rate increases the yield on the cash held by the financial institutions, and the proceeds are reflected in the operating profit of the institution (Johnson, Jensen &amp; Garcia-Feijoo, 2016). Therefore, the benefit of Fed increasing the federal fund rate is accrued by the financial institutions. These institutions hold cash for their clients in accounts that pay interest rate below the short-term rate. The companies benefit from the marginal difference between the yield they generate from the cash invested on a short-term basis and the amount of interest that they pay to the consumers (Rampini, Viswanathan &amp; Vuillemey, 2016). However, with the increase in the interest rate, the benefit increases and the excess income goes directly. For example, if a bank holds $1 million in a customer account that earns him or her 1% and the bank earns 2% for investing the money in short-term notes, the bank will earn $20,000 on the customer account and make $10,000 after paying the customer $10,000. If the Fed increases the federal fund rate by 1% to 3%, the bank makes $30,000 from short-term notes, and after giving $10,000 to the customer, the bank is left with a profit of $20,000.</p>
<p align=”center” style=”text-align:center;line-height: 200%”><b>Strategies That the Financial Intermediaries May Adopt</b></p>
<p style=”line-height:200%”>The financial intermediaries may apply the financial derivatives with the expectation that there will be further increases in the federal fund rate. Financial derivatives are of four types which include swaps, options, futures and forwards (Kim &amp; Tanaka, 2016). They are hedging tools used by the financial intermediaries such as the commercial banks and insurance, to mitigate the risk associated with fluctuations in the interest rates.</p>
<p align=”center” style=”text-align:center;line-height: 200%”><b>Conclusion</b></p>
<p style=”line-height:200%”>The Fed has increased the federal fund rate thrice since 2006. The first increase happened in December 2015, the second happened in December 2016, and the third occurred in March 2017. The favorable economic conditions in which the unemployment rate has declined and the positivity of President Trump&#39;s policy to cut taxes and increase infrastructure and military spending suggest that there will be further adjustments to the interest rate (Williams, 2016). The hike in interest rates affects the stock markets, bond markets as well as the housing markets. However, financial intermediaries which include banks, insurances and investment companies benefit with an increase in the Federal fund rate. The financial intermediaries need to adopt the financial derivative strategies that will enable it to hedge or mitigate risk on their investments. Conclusively, increase in the federal fund rate is a sign that the economy of the US is doing well.</p>

Scroll to Top