From Teeka Tiwari, editor, Mega Trends Investing: China may have given American bondholders an early Christmas gift…
For a while, it looked like a “done deal” that we would see the Federal Reserve hike interest rates in September.
It would be the first rate hike in almost a decade.
But that all changed last week when China devalued its currency by 2%.
As China weakens its currency, American-made goods become more expensive for Chinese consumers. As a product becomes more expensive, demand for that product lessens.
To remain competitive, American companies that export to China will have to reduce their prices. That’ll negatively impact profit margins and earnings.
So would a September interest rate hike by the Fed.
Higher interest rates mean higher borrowing costs… which drive corporate profits lower. They also make the U.S. dollar stronger.
That further worsens the impact of China’s currency devaluation.
If the Fed raises rates right now, it will gun the dollar up, making American-made products even more expensive for Chinese buyers.
According to FactSet Geographic Revenue Exposure data, about 9% of the S&P 500’s earnings are derived from Asia. Most of those earnings come from China and Japan.
So, this is a very real concern for the Fed. I think it will postpone the interest rate raise to see how far Beijing will go in its devaluation.
China’s action has given bondholders another reprieve from the “Grim Reaper” of higher rates… what I call “Income Extermination.”
Remember, though, this is just a temporary reprieve. As soon as the Fed gets a handle on the size and impact of China’s actions, it will raise rates.
Bottom Line: The strategy here is the same. Avoid bonds and bond funds. If you want to own bonds, keep your exposure to below seven years in duration (maturity).