Fed before radical move
That means the turnaround in interest rates for investors
By Benjamin Feingold
05/04/2022, 1:15 p.m
The last time the US Federal Reserve raised interest rates by half a percentage point, Bill Clinton was President. Because of the severe inflation, the central bank feels compelled to take such a big step again. This has consequences for investors.
In the evening it’s time. The US Federal Reserve is likely to raise interest rates by a whopping 0.5 percent. The central bankers communicated this step in advance, so it’s not a surprise. But for investors, this is still a turning point.
In the short term, many of the Fed’s interest rate hikes seem to have been priced into the markets, but they have adjusted to a range of 0.75 to 1.0 percent. If this increase, which is considered almost certain, actually occurs within the expected range, there could even be a relief rally on the capital markets.
This has often been the case in recent years. The short-term favorites therefore include the winners of the past few years: technology stocks, economically sensitive stocks or bonds that could recover after the recent price correction.
But one thing is different from previous years, when investors could count on the Fed and other central banks to keep inflation under control. But the central banks have completely underestimated the current inflation – the corona crisis, disrupted supply chains, rapidly rising energy prices and the Russian invasion of Ukraine are all contributing to persistent, high inflation.
Inflation was low for years before the Corona crisis – for a long time it was well below the 2 percent mark at which central banks consider price stability to have been achieved. In the US and the eurozone, it has shot up and is now more than 7 percent. This is a level not seen in decades. “Wherever I speak to companies, I hear about delivery bottlenecks and planned price increases. The second-round effects on wages are only a matter of time,” says Hendrik Leber from the fund company Acatis.
turning point in monetary policy
Gil Shapira, chief strategist at broker eToro, expects the Fed to adopt a restrictive monetary policy in the foreseeable future in order to curb inflation: “The rapid increase in inflation will initially change monetary policy in the USA for the long term. There will be further interest rate hikes this year, there will be no quick support in the form of bond purchases for the time being”. When it comes to the US Federal Reserve’s decision, Shapira also expects that there will be an announcement that the bond purchases of the past few years will be scaled back.
Even if expectations of the Fed are not disappointed, a lack of bond purchases means there is potential for long-term disappointment. “Since the financial crisis, they have been the engine of the boom in stocks and bonds,” says Jürgen Molnar, capital market strategist at broker RoboMarkets. “Because the central banks lack the leeway for supportive measures, investors have to adapt to a changed stock market landscape,” says Molnar.
But the Fed is not alone. The cautious European Central Bank is also signaling that it will end its zero-interest policy in the summer.
This means that the tightening of monetary policy threatens an economic downturn. In the medium term, for example, stocks that are sensitive to the economy, such as consumer stocks, and stocks that benefit from exports are likely to suffer.
In addition, technology companies with little equity are likely to have a difficult time. They are mostly unprofitable and investors are betting that these companies will generate large profits in the future. “More than half of those shares have already had to go through a correction of 50 percent or more,” calculates expert Molnar. But with interest rates rising, those future gains will be eaten up by higher discounting, putting these tech stocks under pressure.
Bank stocks should actually benefit from rising interest rates because their traditional lending business allows for higher interest margins. The problem: An economic downturn weighs on this business.
In contrast, value stocks have historically performed well in an environment of rising interest rates and high inflation. These are shares in companies that usually have a substantial equity cushion, generate high recurring income, often pay out high dividends and have an attractive share valuation. However, unlike technology stocks, these stocks lack the high growth potential, but that will be exactly the reason why these stocks are exactly the right values for the turning point.
Benjamin Feingold operates the stock exchange portal Feingold Research.
This post is not a recommendation to buy or sell individual shares, ETFs or other financial products. No liability is assumed for the correctness of the data.