Impact of Interest Rate Hike
With the era of cheap money and low interest rate gone, how can investors profit from the age of rising interest rate?
On 10 Nov 2017, Bank Negara gave its strongest signal that the benchmark overnight policy rate (OPR) may be raised. The central bank said policymakers may consider reviewing the current degree of monetary accommodation, given the strength of the global and domestic macroeconomic conditions.
An Overview of current macroeconomic condition
- The US Federal Reserve has raised the federal funds rate twice in 2017 and another hike is expected in December
- Bank of England raised the benchmark interest rate in early Nov 2017 for the first time since 2007.
- The European Central Bank has unveiled plans to cut back on its quantitative easing
So, what sectors are benefited in rising interest rate environment?
Banks are likely to benefit from rising interest rates because their net interest margins are likely to expand as interest rates go higher. Banks make money by borrowing at low short term interest rate (Savings) and lend it out at a higher longer term rates (housing loan). A rate hike could give banks an opportunity to earn more from the spread.
However, banks may also face an increase in non-performing loan due to the borrower worsening repayment capability. Furthermore, when short term interest rate rise faster than long term interest rate, yield curve is flattened. A flattening yield curve will erode bank’s profit.
- Insurance companies
Insurance companies generally don’t make much profit from premiums. They invest premiums to generate profits. Since most insurance companies’ investments are bonds, rising rates can significantly boost profits
When interest rates rise, it pushes the value of currency up. A strengthening Ringgit
helps importers to buy foreign goods cheaply.
Here are some sectors investors should be aware of under the environment of rising rate
REITs perform poorly as rates rise. These companies rely heavily on borrowed money and could see profit margins contract if rates increase. As for REITs with relatively low debt levels, they could face selling pressure as they may seem less attractive when bond yields rise.
- Utilities and telecoms
Utilities and telco companies tend to carry a lot of debt. Moreover these companies don’t produce much growth and pay out most of their earnings as dividends. In other words, these relatively high dividends are more like bonds as they provide a steady source of income to investors. If bond yields rise to a comparable level, utilities seem to be less attractive.
When interest rate increases, interest payments on variable mortgages will increase. A higher mortgage rate will reduce housing affordability resulting to a slump in property sales.
Due to an increase in interest payments, consumers are suffering a reduction in disposable income. This may hamper the consumer sentiment and push back their willingness in purchasing durable goods.
When interest rates rise, it pushes the value of currency up. This will make exporter harder to sell Malaysia made products due to a higher price leading to a reduced competitiveness.
As interest rates begin to rise globally, now is a good time to re-evaluate your portfolio risk and to seek out emerging opportunities. In a rising interest rate environment, buying dividend-rich stocks purely for yield is becoming much riskier than it has been for the past few years.