Are Interest Rate Hikes Imminent?

Higher interest rates could finally be on their way. Last week, Charles Plosser, president of the Federal Reserve Bank of Philadelphia, gave a speech outlining a plan for tightening and selling off some Federal Reserve assets.

If Plosser's straightforward plan comes to pass, the Philly Fed would gradually raise rates to 2.5%-3.5% over the next 12-18 months, while selling off assets and letting assets roll off the Fed's balance sheet.

At first glance, this scenario would benefit investors holding cash, and those who want to buy the bonds and mortgage-backed securities the Fed would be selling. Those who rely on short-term borrowing would end up on the losing side.

One possible group of winners? Large-cap tech. Companies such as Apple and Microsoft have billions of net cash on their balance sheets, and a couple of points on the rate they're earning would add a small tick to earnings.

For possible losers, look to mortgage REITs. Companies such as Annaly Capital (NYSE: NLY  ) , Hatteras Financial (NYSE: HTS  ) , and Chimera Investment (NYSE: CIM  ) borrow short-term and buy longer term mortgage securities. Rising short-term rates will squeeze the rate spreads and the juicy, double-digit dividend payouts investors have been enjoying. Federal Reserve security sales cut both ways for these companies. An increased supply of paper should put pressure on prices and offer buying opportunities. But that same price pressure would also cut the value of paper already on the books.

A speech by one Fed bank president doesn't mean anyone should rush to make changes to his or her portfolio, particularly since Plosser included this disclaimer in his speech: "As always, and perhaps particularly so today, the views I express are my own and do not necessarily represent those of the Federal Reserve System or my colleagues on the Federal Open Market Committee."

Plosser's plan is hardly radical, and it would still keep short-term rates near historic lows. Still, a public statement like this confirms that we're closing in on the end of easy money.  Foolish investors should consider what tighter Fed policy would mean for their portfolios before our country's monetary policy actually changes.

You can follow any of the stocks mentioned using our free watchlist service, My Watchlist.

Fool contributor Russ Krull owns shares of Hatteras Financial, but does not have have a position in any of the other companies mentioned in this article. We can all bank on the Fool's disclosure policy.


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  • Report this Comment On June 26, 2011, at 8:56 PM, billypae wrote:

    Why don't we make like China and hike up our interest rates to 7%. They have had growth for the past 10 years! Greece and Ireland both had very low interest rates for a long time preceding their financial collapse. Japan has been near zero interest for quite some time now and has stagnated for a decade. The countries like China, Brazil and India, who have higher interest rates, have done well. Let's see why? The answer seems to be a direct cause and effect relationship between interest rates and income for the banks. What do the banks do? They lend money at interest. If the banks are forced to lend at zero percent interest, it is no wonder that they are not lending or are committing suicide! We need to raise our interest rates to a decent number like 7.00 for the banks to make any money and profit. Without a profit, they cannot begin to start paying off our debts. We have to stop making the banks out enemies and remember that when we want to buy a house or car, they are our best friends, let us take care of them. Hey Obama, instead of a tax hike, how about a hike in interest rates! It would probably help out the economy greatly! 7.00 may seem high, but when America was prosperous about 20-30 years ago, that interest rate was the norm. Also, my economics class seemed to mention that 7.00 was about market equilibrium normal. Now, 13% is high. 7.00 is probably reasonable to fix the economy in another decade at that level. All of this talk about consumers would not get afford loans at 7.00 interest is baloney because when you need the money, pragmatics will win out. A business will have to agree to pay the 7% interest and as more and more businesses get more loans that the banks would lend instead of invest in other outlets (like they did with derivatives), then jobs would be created and the economy would improve. Thanks for reading, Ben.

  • Report this Comment On June 26, 2011, at 9:55 PM, billypae wrote:

    Why don't we make like China and hike up our interest rates to 7%. They have had growth for the past 10 years! Greece and Ireland both had very low interest rates for a long time preceding their financial collapse. Japan has been near zero interest for quite some time now and has stagnated for a decade. The countries like China, Brazil and India, who have higher interest rates, have done well. Let's see why? The answer seems to be a direct cause and effect relationship between interest rates and income for the banks. What do the banks do? They lend money at interest. If the banks are forced to lend at zero percent interest, it is no wonder that they are not lending or are committing suicide! We need to raise our interest rates to a decent number like 7.00 for the banks to make any money and profit. Without a profit, they cannot begin to start paying off our debts. We have to stop making the banks out to be our enemies and remember that when we want to buy a house or car, they are our best friends, let us take care of them. Hey Obama, instead of a tax hike, how about a hike in interest rates! It would probably help out the economy greatly! 7.00 may seem high, but when America was prosperous about 20-30 years ago, that interest rate was the norm. Also, my economics class seemed to mention that 7.00 was about market equilibrium normal. Now, 13% is high. 7.00 is probably reasonable to fix the economy in another decade at that level. All of this talk about consumers would not be able to afford loans at 7.00 interest is baloney because when you need the money, pragmatics will win out. A business will have to agree to pay the 7% interest and as more and more businesses get more loans that the banks would lend instead of invest in other outlets (like they did with derivatives), then jobs would be created and the economy would improve. Thanks for reading, Ben.

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