New York (HedgeCo.Net) The May employment report shows that there were more jobs added than expected, but the unemployment rate did tick up a notch. Analysts had been expecting the report to show that 225,000 jobs were added during the month and the report showed there were actually 280,000 jobs added. That is the best month of job growth since December.

Because the report was better than expected and because it was the best report in six months, the immediate reaction to the report was to sell bonds and buy the dollar. The obvious interpretation being that the Fed can now move to raise interest rates later this year.Because the situation seems to be changing on a day by day basis, let’s take a quick look at the various monetary policies of the central banks around the world.

• U.S. Federal Reserve—wants to raise interest rates, but have been hesitant due to fear of acting too soon and the possibility of driving the dollar sharply higher causing exports to lag.
• European Central Bank—implemented quantitative easing program and President Draghi expressed this past week that there isn’t any exit strategy in the immediate future
• People’s Bank of China—lowered rates again in May, third cut in six months. Economy slowing, but still growing faster than most developed countries.
• Bank of Japan—quantitative easing program in place and no exit date targeted at this time.

The four scenarios above present the dilemma of the US Fed. If you raise rates domestically while the other central banks are lowering rates or pumping money in to the economy for stimulus purposes, the Fed runs the risk of causing a huge jump in the dollar against other currencies. If this happens, companies that rely heavily on foreign purchases could get hurt as the currency exchange makes their products more expensive.

Looking at how a rising dollar and rising interest rates might impact the different sectors, let’s look at how the models on the HedgeCoVest platform are currently positioned. The most obvious sector that will be impacted by an interest rate hike is the financial sector. When rates are rising, it is traditionally good for banks as the spread between lending rates and deposit rates can get wider and help the banks. However, rates are so low and any hike is likely to be minimal, so the impact should be minimal.

Due to the low number of long positions in the sector, we don’t offer a long-only or long/short model for the financial sector. We do offer the HedgeCoVest Financials Short-only model and it is most heavily short on the banks right now.

Another sector that could be impacted dramatically with a rate hike is the industrial sector and in particular manufacturers like Boeing (NYSE: BA), Caterpillar (NYSE: CAT) and John Deere (NYSE: DE). If the Fed makes the move to raise rates and the dollar rallies too strongly against other currencies, all of the sudden Boeing’s planes become a lot more expensive. The same goes for CAT and DE as their construction equipment becomes considerably more expensive on the export market.

There is hope for these manufacturers though. The hope is that the lower rates and stimulus packages in other countries will create stronger economies and the demand for the products will either offset or outweigh the price increase. Looking at the breakdowns of the HedgeCoVest Index Short-Only model the HedgeCoVest Index Long-only model, we can see that in the long portfolio, less than 5% of the portfolio is allocated to the industrial sector and in the short portfolio, approximately 16-17% is allocated to the industrial sector, giving us a bearish skew toward the sector.

As for other sectors, the hottest sector for the year has been the healthcare sector and the biotech sub-sector. Any rate hike and subsequent rally in the dollar should have minimal impact on the sector as a whole. The materials sector is an interesting one as a rally in the dollar could cause lower prices in oil and gold as they are traded in dollars, but we could also see an increase in demand if the economies of China, Japan and Europe are able to achieve the growth they seek. As for the tech and consumer discretionary sectors, each company would be impacted differently, it just depends upon how reliant they are on export business.

Rick Pendergraft
Research Analyst
HedgeCoVest