Is the world going to explode?
Is the world going to explode?
This is the view of some investment experts, if the Fed were to announce a 1% rate hike this evening.
But let’s take a step back.
The Fed’s next rate decision is 21st September (or Wednesday night AEST).
The Federal’s Reserve’s job hasn’t been easy over the past 12 months, with transitory inflation, inflation, recession concerns and economic volatility.
The Consumers Price Index (CPI) rose 8.3% year on year to August, well above the Fed’s 2% target. In addition, there had been a relief rally as many experts believed that inflation had peaked, was starting to cool more quickly and was on the way back down. So August’s numbers came as a shock.
The stock market has been very volatile, with the S&P 500 down 20%, with the ASX200 down 12% so far this year.
The Federal Reserve is set to meet on 21st September, where they will decide whether interest rates will rise and by how much.
In short, the Fed is considering raising rates to reduce inflation. However, this isn’t their sole focus, as the Fed are trying to reduce inflation whilst doing so in a way that will not burden consumers or businesses.
The two main responsibilities of the Fed are
To provide price stability within the economy
and to provide a healthy job market
What the Fed are trying to do is set interest rates in order to balance those two things against each other.
The federal finds rate, is the interest rate at which banks can borrow money from each other. Banks earn profits by borrowing money at a low interest rate and then lending it out to consumers at a higher rate. Changes to the federal funds rate trickle down through the banking system, influencing interest rates on a variety of things, including mortgages and bonds.
Generally, higher interest rates decrease spending by making it more expenses to borrow money. That decreases demand for goods and services throughout the economy, then slows down the price increases that we call inflation.
However, after the 2008 GFC, America reviewed their mortgage system, where unlike Australia, many Americans have fixed rates for the life of their loans (generally 30 years). So this rate hikes may not trickle through into the market as quickly as other countries (like Australia).
Furthermore, when the Fed raises interest rates, it also runs the risk of hurting the economy - and in particular the stock market- by slowing down spending too much. There is generally a lag in the data that is produced and what is happening in the real world and central banks around the world are battling with this as they continue to raise rates.
In addition, corporations borrow money every day to run their businesses, and when it costs them more money to borrow, it means their profits go down. Therefore, if their profits go down, there is rising pressure on employment (rising unemployment) and ultimately for many companies with large amounts of debt on their books, their stock is no longer attractive.
The markets are expecting a 0.75% increase in rates.
With many of the investment markets having already priced in a 0.75% increase.
The view from the experts are that if there is a 0.75% increase the market will react positively and we may see a relief rally in the investment markets. As this certainty provides investors with further confidence, that maybe we are closer to the end of the Fed continuing to front load rate hikes. However, further market performance will ultimately be guided by what the Fed says about expectations for the next meeting in early November.
However, if we saw a 1% rise, we would see global investment markets explode. We would see stock prices sharply decrease.
Given that in Australia we have a public holiday on Thursday, this could be compounded by two trading days in the US, which could then be dumped on us on Friday.
Investment experts have stated that any decision other than a 0.75% rate increase would be a surprise.
Powell (Fed Chairmen) has been very clear that they feel the need to be aggressive to get inflation under control.
The investment markets are coming to the realisation that the aggressive path the Fed has laid out, they don’t have much room to adjust that.
What Should You Do?
You should ignore the news and the market volatility, by focusing on your goals, underlying investment strategy and financial plan.
For those investors that are not fully invested, we will continue to make small and frequent investments over time. This approach is called dollar cost averaging, which can support you in levelling out the market volatility and reduce the overall risk of buying at the peak of the market.
Should you have any questions or concerns about your personally situation, please reach out to our Newcastle Financial Planners who will be able to review your superannuation and investments and provide you with tailored financial advice to meet your needs.
Resources:
https://www.nerdwallet.com/article/investing/what-to-expect-federal-reserve-interest-rate-decision
https://abc7chicago.com/federal-reserve-rate-hike-meeting-inflation/12239149/
https://www.cnbc.com/2022/09/20/2-year-treasury-yield-reaches-fresh-15-year-high-.html
https://www.business-standard.com/article/markets/us-fed-interest-rate-decision-key-driver-for-markets-this-week-analysts-122091800163_1.html
https://www.nasdaq.com/articles/daily-markets%3A-markets-in-holding-pattern-ahead-of-fed-rate-decision-this-week
https://www.news.com.au/finance/economy/interest-rates/reserve-bank-minutes-reveal-more-rate-hikes-to-come-for-australia/news-story/e1e07ff5318bea2bc5d127e7af9372fd