Before the Federal Reserve’s meeting, the derivative markets were strongly indicating that there was an 80% or greater likelihood of a 0.25% rate hike.
As expected, the Fed followed through with the rate hike announcement, but the response of the markets was somewhat surprising. Both the S&P 500 and Nasdaq Composite indices dropped 1.7%, despite the anticipated nature of the Fed’s decision.
One possible explanation for this unexpected reaction could be that investors were secretly hoping for a pause in the rate hikes, given the ongoing banking crisis. When this did not happen, it may have caused a sell-off due to the perceived negative impact of the continued rate hikes.
Another possible explanation was influenced by recent comments made by US Treasury Secretary, Janet Yellen.
Specifically, Yellen stated that the Federal Deposit Insurance Corporation (FDIC) was not currently considering implementing “blanket insurance” for all banking deposits. This means that depositors with balances exceeding $250,000 may not be guaranteed to have their funds returned to them in the event of a bank failure.
Investors may have become concerned that Yellen’s statement could lead to depositors withdrawing their funds and potentially triggering bank runs. These fears likely contributed to the sell-off of bank stocks, as evidenced by the 6% decline in the SPDR S&P Regional Banking ETF (KRE).
Regardless of the cause of yesterday’s sell-off, it is clear that the Fed remains committed to its course of raising interest rates. The Fed is attempting to balance the competing goals of stabilizing the banking system and controlling inflation, and it believes that it can achieve both of these objectives otherwise it wouldn’t have raised the rates.
Would the Fed succeed? I think it is possible provided that the Fed does not raise the rates too much.
The latest Fed’s Dot Plot shows that most committee members expect the interest rate to peak at 5.1% and remain there for the rest of the year. Rate cuts would only happen next year.
After the rate hike yesterday, the current rates are at 4.75% to 5%. Hence, we are likely to see another 0.25% rate hike during the next meeting.
We are not far from that terminal point and I think raising a bit more interest rate shouldn’t be a big issue. Especially since the authorities are watching the banks closely and problems tend to get managed when given enough attention.
The banking problem is a ‘known known’ now but we are unclear about the ‘unknown unknowns’ and that’s where the black swans lurk.
If the inflation rate refuses to come down and the Fed decides to raise rates further, we don’t know what else could break. The damages will only become evident after they have occurred and, by then, it will be too late to prevent them. As a result, some of us will have to bear the costs of these damages.
What should investors do?
It is important that investors remain positive and believe that we can overcome every adversity thrown at us. There is always something to worry about but the stock market and economy have historically continued to grow over time.
In fact, short-term pessimism is an opportunity for long-term optimists. Investors should keep an eye out for attractive prices and buy. Stay cash if nothing is attractive.
Short-term traders may find volatility appealing, but it is important to exercise caution because volatility can cut both ways – they can either make or lose large amounts of money quickly.
I expect the financial markets will give us a rodeo ride for these few weeks. Hang in there.
