For the upcoming meeting of the Federal Open Market Committee, the Federal Reserve is anticipated to raise interest rates by a half of a percentage point. After that, all bets are off. Bigger increases could be in the cards amid higher inflation.
The Federal Reserve is likely to boost interest rates by a quarter of a percentage point at its next meeting, according to industry analysts, following the release of May inflation figures that showed consumer prices rose 8.6 percent year-over-year. Though some experts said the Fed might wait until its next scheduled meeting in July to raise rates again, following this month’s CPI report, others said it might be too risky for the central bank to wait any longer. “The Fed needs to show resolve,” said Todd Lowenstein, chief equity strategist of The Private Bank at Union Bank. “It can’t afford to appear that it doesn’t have conviction about getting their arms around this stubborn and persistent inflation.”
But Lowenstein has drawn the conclusion that there is a debate among economists concerning whether the Fed should slow down the rate at which it raises interest rates, or temporarily pause the meeting to determine whether low rates would harm the U.S. economy. There is a delay between when rates are announced and when they actually affect consumer behavior.
The Federal Reserve said Friday that inflation is rising faster than it had anticipated, suggesting the central bank will have to raise interest rates more aggressively than it had planned. But the rise in consumer prices may not be enough for the Fed to raise short-term rates when it next meets in June. The central bank has begun a process called quantitative tightening, which could slow consumer demand by pushing long-term interest rates higher. Here’s how that works: As part of the Fed’s 2020 Covid stimulus efforts, the central bank bought massive amounts of bonds and mortgage-backed securities. This so-called quantitative easing has pushed the Fed’s balance sheet to an unwieldy size of nearly $9 trillion.
The Fed is unwinding a few of these assets by permitting the maturity of bonds to be written off and not reinvesting principal payments back into those bonds. With this in mind, long-term economic growth ought to be significantly higher, making it likely that those fears of multiple big rate hikes from the Fed are unfounded.
“Quantitative tightening is definitely going to push long-term rates higher,” said Sandy Villere III, a portfolio manager with St. Denis J. Villere & Co., “and I don’t think the market is factoring that in.” Some investors are expecting an overly hawkish Fed, he added. “The market overreacted and that is giving us opportunities to buy some things.” Villere said that bonds and some small-cap US companies are looking attractive. But he conceded that investors have to tread cautiously. There is no guarantee that the Fed can slow the economy without causing a recession. “We’ll see if the Fed can pull off this magic trick and have a soft landing instead of a crash landing.” Others worry that big rate hikes from the Fed aren’t going to help bring down inflation, especially since a big chunk of higher prices are due to surging energy costs.
“We expected to reach the height of inflation,” said Jay Woods, chief market strategist at DriveWealth. “The Federal Reserve does not control the price of energy and oil products. Consumer spending patterns will change considerably.”
Tech canaries in the coal mine?
Tech stocks have been having a difficult year. The Nasdaq Market is at an all-time low as investors fear about the impacts of rising interest rates on Silicon Valley’s profits. Are the fears justified? Investors should get a better understanding of the situation after two enormous software companies Oracle (ORCL) and Adobe (ADBE) report earnings this week.
Both Oracle and Adobe have a lot of business with Corporate America. Oracle sells database and customer relationship management software and is a leader in the field, while Adobe’s creative tools (PhotoShop, Acrobat and InDesign to name a few) are used by armies of business graphics designers. Shares of Oracle and Adobe have, like the rest of tech, both tumbled this year. Oracle’s stock is down nearly 25% while Adobe has plunged more than 30%. Investors will be paying close attention to see what each company has to say about the outlook for corporate tech spending for the next few months and beyond. They could give Wall Street more clues about how other cloud software giants are doing; Microsoft (MSFT), Google (GOOGL), SAP (SAP) and Amazon (AMZN) are all due to report earnings soon too.
Another cloud computing chief, Dow component Salesforce (CRM), recently reported strong earnings. However, the company also reduced its earnings outlook and said it would be “measured” in attempting to recruit more workers in the future.
