On Wednesday, the Federal Reserve raised its key interest rate for the first time since 2018. And it did so by the expected 25 basis points (0.25%). So far, so good. But much more important for the markets is what this central bank will do with interest rates in the coming months. And that should actually make investors feel sick. Today we discuss the importance of the right stock selection.
US Monetary Policy: 10 More Interest Rate Steps to Follow
The “dot plot” published with the latest interest rate decision shows that the members of the Federal Open Market Committee expect a median key interest rate of 1.88% by the end of the year. This would correspond to six further interest rate steps of 25 basis points each!
But that’s not all. A key interest rate of 2.8% is expected by the end of 2023, which is even higher than previous market expectations. This would correspond to four further interest rate steps in the coming year of 0.25% each.
The first interest rate step this week would thus be followed by 10 more. With its current rate hike, the Fed is already reacting far too late to the significant rise in inflation, which recently reached 7.9% in the United States. This is the highest level in around 40 years. There is a great danger that the central bank will raise interest rates massively in the middle of a downturn, thereby triggering a recession.
It’s Not Just the Key Interest Rates
And there is a second adjusting screw that the central bank can work with: bond purchases. These were already discontinued at the beginning of March, which pushed bond yields up and liquidity down. But here the Fed wants to go one better. It wants to reduce its balance sheet total, i.e. sell bonds held.
I wonder: how will the market withstand the one-two punch of ever-higher policy rates AND higher bond rates in the wake of the balance sheet reduction, when at the same time the economy continues to slide?
Why the Right Stock Selection is Critical Now
To be sure, equity markets initially cheered the central bank’s interest rate decision. But how stable will such short-term bouts of sentiment be when corporate profits continue to plummet in the face of high inflation, dysfunctional supply chains and sales markets collapsing due to sanctions? And in the middle of a valuation bubble?
Let’s be clear: I’m not skeptical about all stocks. There are definitely a few stocks that are benefiting from the current situation (strong inflation, shortage economy). Here, valuations and trend behavior are right. This is where you need to be invested.
But for the mass of shares this does not apply at all. Here I see absolutely black for the next few months. At least until attractive valuations are reached again. Unfortunately, we are currently still about 20% away from that.