To Get Rates Up, Fed Needs To Drain Liquidity

This is slightly technical, but I will do my best to explain:

 Short-term interest rates are controlled by the central bank but they are a function of the market for short term (usually on an overnight basis) loans and deposits between banks.

Everyday a bank looks at its cash position (daily cash flows from deposits and withdrawals by customers) and determines whether it needs to increase (borrow) or decrease (lend) the cash.

The central bank creates the appropriate amount of liquidity in the system to allow them to do so.

If there is an abundance of liquidity (as there has been because central banks have been maintaining a low interest rate policy) then interest rates for this day to day borrowing and lending are rather low.

However, when a central bank wants to raise interest rates (as the odds expect the Fed to do so tomorrow), they reduce the amount of liquidity in the system which makes the cost of the day to day borrowing and lending rise: (economics 101) supply of money available goes down, the cost of money goes up.

The reduction of liquidity, likely in the billions of dollars, has reverberating effects across the financial system and financial markets. Borrowing becomes more expensive. For those who have borrowed to invest (we call this using margin and as is shown in the above chart it is at record highs) the increased cost becomes an issue.

As financial institutions scramble to find the necessary liquidity to maintain their cash flows, there is a greater likelihood that they will sell expensive assets to raise some of the cash required, instead of borrowing more.

What assets are expensive?

At the risk of sounding repetitive, US equities are.

We will discuss this and other global economic issues and how they impact our decisions on investing for our and our clients portfolios today in our weekly client webinar, which is just one of the ways we (at High Rock) keep our lines of communication with our clients open. We will post the recorded version on our website http://highrockcapital.ca/current-edition-of-the-weekly-webinar.html at or about 5pm EDT today.

For Wealth Management, there is an alternative to the traditional Advisor channel and we and our Disciplined Investing strategy are it. 

Feel free to tune in to find out why.