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  • The Fed raised its benchmark interest rate by 0.75 percentage points at its September meeting
  • Further hikes are expected as the long-term interest rate is expected to reach 4.4% in 2023
  • It’s bad news for companies and the economy in general, with markets faltering after the announcement.
  • Investors need to think outside the box to make profits in this type of environment, and pair trades are one option to consider.

The Fed was widely expected to raise interest rates by 0.75 percentage points at its September meeting, the third time in a row that it had been raised. And that’s exactly what happened.

The increase raises interest rates to a range of 3 to 25%, the highest level since before the massive wave of cuts that came as a result of the 2008 global financial crisis.

In addition to releasing its latest target rate, the Fed also announced its revised economic forecast for the remainder of this year and into 2023.

It paints a pessimistic picture that is unlikely to calm the nerves of both companies and investors, but fortunately there are always ways to explore and unique angles to look for profits.

Let’s turn to the Federal Reserve’s announcement and look at ways that investors can generate returns in what is proving to be a challenging environment.

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Fed announcement overview

In addition to increasing the policy rate by 0.75 percentage points, federal economists also provided a set of new forecasts for the economy.

Economic growth is expected to be a weak 0.2% for 2022, before rising slightly to 1.2% for 2023. Unemployment is expected to rise as well. At the moment, it is at 3.7%, which is low, but it is expected to slowly rise to 3.8% by the end of the year and then reach 4.4% in 2023.

Perhaps most surprisingly, the Fed expects inflation to drop significantly over the next 12 months. As of this meeting, the headline rate is expected to fall to between 2.6-3.5% in 2023.

This decline is unlikely to come without suffering for businesses and consumers, as the base rate is expected to rise to 4.4% by the end of 2022 and then rise again in 2024 to an estimated 4.6%.

What does rising prices mean for the housing market?

The Fed's main goal in raising rates is to reduce consumer spending. When the underlying rate rises, it makes borrowing for banks more expensive. This increase in costs is passed on to its customers in the form of an increase in interest rates on debt.

Be it personal loans, car loans, credit cards and of course mortgages, it makes them more expensive.

The increased cost of debt means that families have less money to spend on other things. Less money means less demand for goods and services, which increases supply and leads to lower prices. Or at least prevents them from rising too quickly.

It's not good for businesses but it takes the heat out of inflation.

Mortgages have the biggest impact on family budgets because they are generally one of the biggest, if not the biggest, expenses.

The average 30-year mortgage rate has recently risen to 6.25%. This is the highest level seen since the days of the 2008 global financial crisis.

This is a 35 basis point increase that occurred before the Fed meeting, with a 0.75 percentage point rate hike already expected. That means we may not see another increase from here, at least until the next Fed meeting. closer.

As for the broader housing market, the damage expected to be felt by the rest of the economy is not expected to be avoided. Federal Reserve Chairman Jerome Powell stated that the housing sector is likely to undergo a correction after going through a period of "hot" prices.

How will savers be affected?

On the other hand, the rate hike is good news for savers. The group that is often forgotten when it comes to changes in the prime rate, they have the opposite problem of borrowers.

Lower interest rates mean there is less incentive to save, as meager levels of interest force people to look for other ways to generate a return. When the Fed tries to stimulate the economy, that's a good thing.

Lower rates on bank savings can mean more money goes into assets like bonds and stocks, which can increase market activity and boost prices. It can also lead to more spending as there is less incentive to save money.

This has been the situation since 2008, with savers now accustomed to receiving almost nothing on their savings accounts and CDs. With interest rates rising, this may finally be starting to change.

The increased rates mean that banks can offer significant interest on their cash-based accounts. As you would expect, it has the opposite effect of lower prices. Savers become more motivated to keep their money in the bank, if they feel they are getting a decent return.

With bank interest rates often dropping below 1%, it made little sense for savers to consider putting that money into the stock market instead. If rates go up to 4% or more, this question becomes much less clear-cut.

Of course the interest rate is still negative 4% in real terms if inflation continues to rise as it is now, but nonetheless we may see increased savings and CD rates begin to change some consumer behavior.

For businesses, this is very bad news, as they take more cash out of the system which means less money is spent.

All this in the hope of reducing inflation. Federal Reserve Chairman Jerome Powell has made it clear that this is their number one priority, even if it means hurting the economy in the short term.

How did the stock market react to the rate hike?

Although it was widely expected and supposed to be priced, the S&P 500 was down 1.71% in Wednesday's trading. Concerns are growing about the outlook for the US economy, as Powell's announcement shows that a recession appears more likely.

The Nasdaq Composite was worse off, down 1.79% throughout Wednesday and the Dow Jones down 1.70%.

It is possible that the decline in the markets was not a result of the September rate hike, but rather the result of expectations and the clarity provided regarding additional increases. There are two more FOMC meetings before the end of the year, and it would be surprising not to announce price hikes on both.

What options are available to investors now?

With interest rates on cash accounts rising, it can be tempting to move some money out of the markets into this safe haven.

There are two main problems with that. Number one is that most investors are likely to incur some heavy losses at the moment, and selling and moving into cash will lock in those losses.

The best CD rates on the market are still just over 3%, and they come with serious lockout periods of up to five years. With inflation still at very high levels, you would be making a negative real return.

This is not a great strategy.

So we're probably headed for some economic turmoil, the stock market is already looking choppy and the cash still isn't up to the party. You can try stock picking, but this is risky and can easily end up worse than just depositing your money in the bank.

One answer is to use pair trades to invest in relative valuations. We've created a number of investment groups that use pair trades to do just that.

A good example of this is our large cap crew. In volatile markets, large companies tend to outperform small and medium-sized companies. They tend to have more stable revenue, more cash reserves to reference and rely less on attracting new customers to generate profits.

That doesn't mean they can't go down in value, but they often go down less than smaller companies can find the economic slowdown very difficult.

Large Capsule Group is looking to capitalize on this difference by taking a long position in the largest 1000 companies and a short position in the next 2000 companies. This means that even if the market is trending sideways, or even declining, investors can profit as long as large companies hold out better than small or medium-sized companies.

It's the kind of trade that's usually reserved for baller hedge fund clients, but we've made it available to everyone.

Download Q.ai today To access investment strategies backed by artificial intelligence. When you deposit $100, we will add an additional $100 to your account.