Undecided or unsure

IT SEEMS that investors on Wall Street and other markets influenced by it are undecided or unsure of what the latest rate increase by the US Federal Reserve may bring.

At the close of trading on Wednesday, the S&P500 was up 3 percent boosted by the rate liftoff two days earlier. The gains, however, were cut by half the following day and completely wiped out on Friday when the benchmark index continued to fall.

Nasdaq also fell 79.47 points or 1.59 percent. This brought the index back close to its April level of 4,931.81 and 416.59 points or 9.24 percent away from its lowest close for the year at 4,506.49.

The Dow Jones Industrial Average also dropped 367.39 points or 2.1 percent when it closed last Friday at 17,128.45. To one news report, it was the Dow’s “worst day since Sept. 1.” It brought the Dow back to where it started to take off on Jan. 30 at 17,164.95.

The PSEi similarly fell on Friday but unlike the three major indices of Wall Street, the PSEi still ended the week with a weekly gain of 132 points or 1.96 percent as it closed at 6,867.07.

For the week, foreign investors remained net sellers but to a lesser degree—their trade hit P1.67 billion, down from P2.46 billion the week before. This made the percentage of foreign investors’ transactions to total market business fall to 55.92 percent from 57.14 percent.

The daily average value turnover for the week, which rose to P5.56 billion from P5.29 billion the week before, may still have been augmented by foreign investors’ buying transactions rather than by local punters’ trading activities. Last Friday, foreign investors’ transactions were up to 62.89 percent after a four-day average of 54.09 percent.

Quantitative easing

What is making investors uncertain about the rate increase in the US? What exactly was quantitative easing or QE?

When QE was being planned seven years ago, there was a debate as to what it could possibly bring about. The major concerns were that it might cause runaway inflation and result in the collapse of the US economy. These concerns made the Wall Street and other equity markets wobble.

The same thing happened following the reduction of the QE package, known as the taper program, which took place between December 2013 and October 2014. Investors’ uncertainty again resulted in market instability.

Now that the US Federal Reserve officially ended the QE program with the adoption of a small rate hike, a similar reaction of uncertainty and market volatility happened.

The QE aims to increase the size of the balance sheet of central banks like the US Federal Reserve and raise the amount of credit available to borrowers.

For this to happen, the central bank issues new money “with electronic cash that did not exist before.” The central bank then uses it to purchase assets like US treasury bonds from banks. The cash the banks received for the assets can then be loaned to borrowers.

QE is also called “printing” money, as it essentially entails creating money from nothing. It is called “quantitative” for it increases the size of bank reserves.

Since obtaining loan is made easier with QE, interest rates drop and consumers and businesses can borrow and spend more.

Theoretically, increased spending results in growth in demand for goods and services, job creation and more investments that will fuel economic growth. But if the money created in QE circulates rapidly, this may induce inflation that may choke economic growth and send the economy back to a recession.

Before the implementation of QE, the usual tool used by central banks to perk up economic conditions and keep inflation in check was to adjust the interest rates at which banks borrow overnight. The move would reduce bank’s funding costs and encourage them to extend more loans.

The central banks also use interest rates to curb credit and spending from getting out of hand. They also resort to raising interest rates.

When the financial crises struck, central banks initially used interest rates as a management tool. Overnight interest rates were reduced. But even when they were driven down to almost zero, it failed to spark economic recovery. Banks shied away.

Bottom line spin

The Fed believes QE has successfully raised economic activities in the US, and that a return to increasing interest rates will pave the way to real economic vitality.

As a first step, it raised interest rates to a quarter point. By the end of 2016, “Federal funds rate is estimated to be about 1.375 percent, up from its current, new range of 0.25 to 0.50 percent.”

This means we’ll have to brace for at least four more interest hikes next year.

Banks and related financial institutions will “make the cost of auto loans, credit card borrowing, home equity lines of credit, mortgages and other loans more costly.”

Banks should raise interest rates in order to attract cash in the form of deposits. But they are quite awash in cash and don’t need to attract more at the moment. In this case, there is little incentive for them to pay more interest on savings accounts.

These and other imagined scenarios that may happen following the rate hikes are keeping the market down and investors undecided and unsure of what to do.

(The writer is a licensed stockbroker of Eagle Equities, Inc. You may reach the Market Rider at [email protected], [email protected] or at www.kapitaltek.com)