FOMC implication towards the Bear Market

 

The recent FOMC result announcement on the 15th of June of the interest rate increase .75 basis point hike with the new range of 1.5% to 1.75%. The increase resulting from the 2-day June policy meeting is in line with the market expectation. It is the largest rate hike since 1994.

 

Along with the announcement, it indicates for the future GDP growth projection, Fed cuts the 2022 forecast estimation to 1.7% with a 1.1% decrease from 2.8% initially. On top of the announcement, the whole core inflation outlook declines its target to 2.3% by 2024. Federal Reserve officials are now projecting a year-end Federal funds rate of 3.4% far exceeding the initial projection of 1.9% made in March.

 

The market moves relatively positive with the news. Nasdaq was up 2.49%, S&P 500 up 1.49% and Dow Jones Industrial Average rose by 1%.

 

Prior the FOMC

Over the past week, the stocks market had reached its downfall ride, with S&P down more than 7% and in contrast, the 2-Year Treasury Yield is up more than 20%. Worsen the condition, CPI report the last Friday signalled the US economy had reached the 40-year inflationary high surpassing the previous high set in March of 8.5%. The report had imposed pressure on Fed in selecting their tool to tame the surging inflation. Even the words that Jerome Powell uses in his post-FOMC speech must be carefully chosen to prevent adverse reactions. The current rate of 8.6% is 4 times the 2% Fed’s long-run inflation target.

 

How does the FOMC result impact the stock market?

When Federal Open Market Committee (FOMC) set the interest rate, it has a ripple effect across the entire economy. It usually took around a year for the economy to show its impact and on the other hand, for the stock market? The impact can be seen often almost instantly.

The interest rate that impacts the stock market is called the federal fund rate; the rate that depository institutions charge each other for the overnight loans. The rate is used to control inflation. Increasing the rate, will in conjugate with the attempt to lessen the money availability supply. With this, money will be harder to obtain. Vice-versa if Fed decided to reduce the rate, it will increase the market supply in circulation. 

Along with the federal funds rate, the prime interest rate largely circle around the fed fund rate. It will also create the basis for other loans such as mortgages, credit card APRs, and business loan rates. So, how does the FOMC affect you? As the Fed funds rate control the money circulation- basically it impact your retirement portfolio, the availability of loans for house purchases, business, next housing bubble, even potential of your salary raise.

 

Fundamental reason

FOMC meeting often leads to a positive impact on the stock market; the purpose of the rate adjustment is to combat panic, and inflation, strengthen the financial system and maintain its stability of the financial system. It is very contrary for the impact of the FOMC meeting to result in a negative correlation for the stock market. 

 

However, when there are less money circulate for loans for personal and institutional- Lesser margin can be made for stocks purchasing. This will indirectly affect the stock market as the demand will decrease while the supply retain. Thus, correction usually will follow suit.

 

How should you position your portfolio to maintain your portfolio returns?

While market sentiment may remain cautious, investors may look out for bargain hunting opportunities allocations to value stocks, particularly sectors that will directly benefit from rising interest rates such as REITs, consumer, financial and banking stocks.  

Financials and banking are naturally sensitive to interest rate change. For example, interest income coming from credit loans as reflected from the spike of interest rates. The higher the rate, the higher the profitability for banks, all things being equal. 

 

Another sector that could potentially benefit is consumer discretionary. As Interest rates drive inflation in the opposite direction. Higher interest rates reduce inflation whereas lower interest rates lead to a rise in inflation. The right amount of inflation is good for the economy. Thus, consumers have more disposable income to splurge on goods and services.

 

 

 

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