How Berkshire Hathaway Benefits From Fed Rate Hikes

I am expecting a slow, gradual increase in interest rates over the next two years. After the Federal Reserve raised short term rates (Federal Funds rate) by 1/4% today, and I believe they will again three more times later this year, then interest rates will be 1% higher a year from now.  Federal Funds were at 1/2 – 3/4% (near historically low levels) before today’s rate increase.  Since Berkshire currently has about $85 billion in cash invested primarily in short term Treasuries, a 1% increase in short term interest rates results in an additional income of $850 million per year for Berkshire.  Furthermore, Wells Fargo and Bank of America, two of Berkshire’s largest equity investments, will benefit from an increase in earnings as interest rates rise.  Their corresponding share prices should then also increase.

In a meeting with University of Maryland students on November 18, 2016, Warren Buffett said: “Stocks are cheap if long term rates are at 4%, four to five years from now.”  Currently, the 10 year Treasury is yielding only 2.50%.  In today’s environment, both Berkshire’s businesses (81% of assets) and its equity portfolio (19% of assets) should continue to do fine if interest rates rise gradually as most economists, including myself, are expecting.

This blog post has been published by Investing.com and ValueWalk.