Many are asking what is the big deal about raising rates a mere quarter of one percent. It seems like a very insignificant increase that would not significantly impact willingness of anyone to take out a loan. But that is true only if you think about the real economy where goods and services are produced, houses bought and sold etc.

When it comes to financial markets the rate hike is a huge deal. Seven years of zero interest rates created many speculative financial transactions that would depend on the Fed Funds Rate being zero. According to E.D. Skyrm from Wedbush Securities a rate increase of a quarter of a percent actually means a withdrawal of up to $800 billion from financial transactions worldwide. This is a huge sum of money that will simply disappear from the financial markets and could create selling pressures across the board. This is why last two times when Fed was preparing to hike rates, a tremendous volatility ensued in a stock market. This time is no exception, Dow Jones just had a roundtrip move of 1,000 points in only a few days, highly unusual behavior that indicates significant uncertainty on the part of market participants.

The effects of a rate hike will likely be a decrease in value in virtually all financial assets, houses, stocks,  bonds (whether decrease is moderate or significant remains to be seen). The only financial asset that is set to benefit from the increase is the U.S. dollar and possibly US Treasuries. Given this picture, it would make sense to hold off on big purchases, monitor the situation and hold on to your cash. If Fed’s continued rate increases create large price drops, this may present a great opportunity to buy assets on the cheap, whether they will be financial investments like stocks or bonds or real assets such as a house.

China

Throughout 2015 our readers know that we forecasted continued trouble for the Chinese equity market. Centrally planned support for the markets cannot take you very far in the presence of major trends like described above. In addition to unfavorable trends above, China has built up its own set of internal imbalances with a credit bubble of epic proportion.  We are going to write a separate story analyzing China situation shortly, but the basic conclusion is China has massive deleveraging that is sure to cause it to devalue to currency to avoid defaults.

Our research team at RiXtrema has created a number of scenarios to help clients test vulnerability of their portfolios to these outcomes. Here are they:

1.     Massive Dollar Rally – In that scenario we shock Bloomberg Dollar Index 30% against its basket of corresponding currencies.

2.     S&P 500 Energy drops 40% - Energy stocks have declined, but nowhere near a level that would be indicated if energy prices remain low. We highly recommend testing your portfolio against such an event.

3.     Yuan Devaluation – Continued yuan devaluation is certain, we recommend starting with a shock of 5% against the dollar.

4.     Grexit – We also recommend continued vigilance about Europe. None of the problems in Greece (or Portugal/Spain for that matter) have been resolved. A new day of reckoning is looming and debt continues to increase.  Just because something is not in the headlines, does not mean it should be ignored.