On April 21, Federal Reserve Chairman Jerome Powell cited the clearest indication of support for a significant increase in the Federal Reserve’s (“Fed”) benchmark interest rate. Additionally, as financial markets and investors assimilate the observations below, investors should revisit their overall portfolio construction and asset class allocation, risk tolerance, targeted returns portfolio and tax considerations, including unrealized portfolio gains and losses, investment time horizon and other factors. – which are specific to them.
Federal Reserve activity to reduce and manage inflation
The Fed Board of Governors reviews and determines the discount rates to be applied by the Federal Reserve Banks. However, Chairman Powell’s April 21 comments cite a likely 0.5% Fed hike, the main reason being to reduce and manage inflation.
The Fed’s federal discount rate and the federal funds rate (the interest rate that banks use to lend money to each other) are used to control the supply of available funds and other interest rates. dependent interests. Increasing the discount rate makes borrowing more expensive, thereby reducing the available supply of money, which then increases short-term interest rates and helps keep inflation in check.
In February 2020, the federal funds rate was 1.58% compared to 0.13% in February 2010. In July 1954, the rate was below 1% and reached an all-time high of nearly 20% in 1980 and 1981 This spike was the result of efforts to counter inflation, which resulted from President Nixon removing the United States from the gold standard in 1971.
Mortgage rates are rising
On April 21, the Federal Home Loan Mortgage Corporation (“Freddie Mac”) reported that the average interest rate for a 30-year fixed rate mortgage had risen to 5.11%; this rate was 3.22% at the start of 2022.
As interest rates rise, the cost of borrowing money becomes more expensive. This makes the purchase of goods and services more expensive for consumers and businesses. For example, as mentioned above, buying a home becomes more expensive as mortgage rates have risen. Financing the growth of a business also becomes more expensive as lending rates rise. When this happens, consumers spend less, causing the economy to slow down.
The impact of interest rates on inflation
In general, rising interest rates stimulate inflation, while falling interest rates slow inflation. When interest rates fall, consumers historically spend more because the cost of goods and services is cheaper because financing is cheaper. An increase in consumer spending means an increase in demand, and an increase in demand causes prices to rise, which can usually lead to inflation. Conversely, when interest rates rise, consumer spending and demand decline, and prices and inflation follow.
Interest rates and stock markets
On April 22, the Dow lost about 600 points in afternoon trading while the S&P 500 and Nasdaq were down 1.8% and 1.7%, respectively. Investors reacted to both Chairman Powell’s remarks and corporate earnings results; in general, the main stock market indices fell by 2%.
There was another rise in 10-year Treasury yields, which, in turn, caused investors to steer away from the high-growth tech sector. US stock indices are now on track to likely post a decline for the week ending April 22. In general, rising interest rates hurt equity performance. As interest rates rise, individuals see a higher return on their savings. This eliminates the need for individuals to take additional risk by investing in stocks, which leads to lower demand for stocks.