The Dog & Pony Show

Key Takeaways:

• We get the 2:00 p.m EST interest rate announcement by the Fed which is widely expected to lay out the first interest rate hikes since before the pandemic.
• With unemployment low and consumer savings high, the Fed feels they have enough room to raise the cost of borrowing and slow down demand in the economy to dampen inflation without severely hurting mainstreet.
• Many of the most beaten down sectors, such as technology stocks, have priced in the rate hikes and could be due for a bounce over the next 90 days.

At 2:00 p.m EST, the Federal Reserve’s Open Market Committee (FOMC) sets its interest rate policy for the next month.

What to Expect

Markets expect the Fed to raise its target Fed Funds rate from 0% to either 0.25% or 0.50%. Typically the Fed changes the rate by increments of 0.25%.

How it Works

The Fed Funds rate is the rate that banks effectively lend to one another overnight. To do this, the Fed will:

• Change the interest rate it pays on balances banks keep at the Fed
• Changes the rate that the Fed will conduct overnight reverse repurchases. Banks not eligible for interest on reserve balances will buy securities from the Fed and then sell them back at a higher price the next day, essentially paying the bank interest.

What it Does

High Fed Funds rates cascade through the banking system, raising the costs on loans and interest paid to savers.

It also pushes the price of government debt down to make their yields move higher.

Since government debt pays a flat payment (coupon) at regular intervals, the yield on that debt, the coupon divided by the price of the bond, can only go up when the price of the bond goes down.

Ideally, higher rates influence consumers and businesses to save more and spend less.

That’s important since inflation is driven by demand exceeding supply.

The Outlook

Many of us expected supply chains to catch up by now. That hasn’t happened.

Demand is high. However, many companies and customers are placing double orders.

The real challenge is still supply, driven in part by countries like China that aren’t keeping up with global needs.

At the same time, soaring oil prices are creating a de facto tax on consumers. By paying more at the pump, we have less money to buy other products and services.

Due to heavy government spending and consumer savings, American households hold an immense amount of cash at the moment. That will blunt higher interest rates for the time being. 

So, don’t expect inflation to magically disappear anytime soon. It may take months to a full year to see the effects.

The Bottom Line: Higher interest rates hurt high growth stocks like technology companies such as Tesla (TSLA), Spotify (SPOT), and the like.

However, many of these names have already priced in rate hikes. Therefore, some of them could be due for a major revival in the coming months.

Keep an eye on the Nasdaq 100 (QQQ) and the Semiconductor ETF SMH as potential outperformers in the next 90 days.