The Other Side of Rising Interest Rates

Editor’s note: The markets and our Chaikin Analytics offices will be closed Monday, June 20, in observance of the Juneteenth holiday. Because of that, we won’t publish the Chaikin PowerFeed e-letter. Look for your next issue on Tuesday, June 21.

Interest rates are on the move yet again…

Almost everyone has talked about interest rates over and over in recent months (including us). And I bet you’re starting to get tired of it.

But the topic is unavoidable. After all, the Federal Reserve just announced another 75-basis-point hike to the benchmark rate yesterday.

By this point, we all realize that rising rates are tough for stocks. And we’ve seen that rising rates are bad for bond prices as well.

However, this story has another side…

You see, rising rates don’t just mean that bond prices are falling. They also mean that the payouts on bonds are rising.

That’s great news for risk-averse investors. It means they can get higher payouts on more conservative bond plays.

Now, maybe your gut reaction is, “So what?

But this side of the story has worldwide effects. That’s because it kicks off a global hunt for yield…

Put simply, when interest rates rise, the demand for their higher payouts rises as well. And that change has the power to push money around on a worldwide scale…

Imagine European bonds pay 1%. But now, similar bonds in the U.S. pay 2%.

That’s a 100% difference in return. And it’s the kind of setup we’re heading toward.

It leads to a trickle-down effect…

In our example, folks outside the U.S. would want to buy the American bond because of its higher yield. But they would need U.S. dollars to do that.

Most individual investors don’t think about changes in currency demand. But right now, more than any time in the past 40 years, it has big implications for folks like us…

Economics 101 tells us that demand drives prices up.

In a world of rapidly rising U.S. rates, that means demand for the dollar is soaring. And by extension, the dollar is getting “stronger” against other currencies.

We can see this trend playing out in the rising exchange rates with foreign currencies. Over the past year alone, the U.S. dollar is up anywhere from 8% to 13%. (The exact number depends on the foreign currency.)

That’s good news for some folks. It’s good for U.S. travelers on overseas vacations, for example. And more importantly, it’s also good for anyone buying foreign goods…

American businesses that buy foreign products will benefit from a stronger U.S. dollar. They’ll be able to buy the same amount of goods at cheaper prices.

And in time, that will cut down on the pain of inflation. In fact, this effect is so powerful that it will eventually lead to economic recovery as the cost of doing business falls.

In turn, that will lead to lower rates. And before you know it, we’ll find ourselves in the next economic boom.

It doesn’t feel like it now. But the bottom line is…

Rising interest rates aren’t horrible for everything. It’s part of the cycle that will get us to a normalized, post pandemic world.

Good investing,

Karina Kovalcik

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