The economic volatility that markets have experienced this year has certainly made the Fed work extra hard to maintain a semblance of stability. The Consumer Price Index rose 8.2% in September, a level way above the 2% long-term Fed target. Looking at the stock market, the market averages including the S&P 500 have suffered significant losses year to date.
The Federal Open Market Committee (FOMC) is scheduled to meet on November 1-2 where it will decide whether or not to sustain the tightening. Looking at the delicate balance between the interest rate and stock markets, the Fed will be careful not to jeopardize further the economic outlook.
Why The Fed Is Raising Interest Rates
The main reason for the Fed dialing up the interest rate is to help cool off the economy. Inflation has been on the rise and is wreaking havoc not just on businesses but also consumers.
The Federal Reserve is mandated by law to provide price stability as well as spur growth in employment. To balance these two goals simultaneously, it uses monetary policy tools, one of which is the Federal funds rate. This is the rate at which banks borrow funds from each other.
When the federal funds rate increases, the benchmark interest rates also increase. For instance, when the September funds rate increased by 75 basis points, the benchmark interest rates also increased to the range of 3.0%-3.25%.
Higher interest rates disincentivize borrowing thereby reducing spending on goods and services. A good example is a rise in mortgage costs that has led to a fall in the demand for housing. Such squeezes on-demand help to lower the prices hence inflation number also comes down.
However, during times of high-interest rates, businesses find it costly to borrow funds and repay existing credit facilities. Consequently, margins get squeezed, and earnings drop. This makes their stocks to be unattractive in the market.
What Are Market Expectations for The Upcoming FOMC Meeting?
Market averages such as the S&P 500 and Nasdaq are gearing up for another rate increase of about 75 basis points. Any raise that is either above or below 75 basis points will most certainly be a surprise to the markets.
The Federal Reserve chair has been categorical on the need to be aggressive to contain the high rates of inflation. Following the rate hike on September 20-21, attention has now shifted to November 1-2 where expectations are that the Fed will continue with policy tightening.
How The September Inflation Print Affects the Fed Decision
The annual rate of inflation for September 2022 is 8.2%, one-tenth of a percent higher than the 8.1% forecast. The market indices fell by a couple of percentage points following the data release. Because of the higher-than-expected inflation numbers and strong job growth, the Fed will be forced to stick to its guns.
Markets are usually anticipatory. They try and predict what the rate will be like in the Fed review. If there is a likelihood of rates going up, the stock market will price that in and react negatively.
Long-Term Investors and The Fed Interest Rate Policy
If you are a short-term investor or trader, interest rate movements are very crucial numbers to watch. Traders take positions that close at the end of the day. When the Fed increases the Fed rate, stocks begin to fall in price. A trader who shorts security can benefit if the stock moves in their favor.
Long-term investors on the other hand should not pay much attention to the day-to-day stock market volatilities. Instead, they should regularly update their portfolio by making frequent contributions. Using dollar-cost-averaging and other investment strategies, investors can take long profitable positions in securities.
The stock market is one of the primary channels through which companies raise funds. Looking at the Fed minutes, the next FOMC review will most likely sustain the 75 basis points or even go higher. The immediate reaction of the stock market will be to shed a few points in anticipation.