Fed Up

Fed rate hike sinks stocks

Image source: Dmitri Zimin, MDOGAN - Shutterstock

What's going on?

No one was surprised by the US Federal Reserve’s decision to raise interest rates on Wednesday, but the stock market drop that followed was a bit of a shock.

What does this mean?

America’s central bank effectively said that recent economic data showed the country was on a strong enough footing to justify an immediate rate increase. But it also indicated that it’d really take its foot off the rate hike accelerator next year, with only two increases likely (versus four this year). Previously, investors had been predicting three 2019 rate rises.

Since higher rates make borrowing more expensive and encourage saving instead, investors worried about rapid rate hikes weighing heavily on future economic growth might’ve been pleased with the decision to ease off more on further rises. Not so…

Why should I care?

For markets: It’s not just rate rises slowing.

The Federal Reserve also slightly lowered its economic growth forecasts for the US this year and next, perhaps spooking investors on Wednesday and Thursday. On the one hand, slowing down interest rate rises gives an economy room to grow without the pressure of quickly rising borrowing costs eating away at companies’ profits. On the other, a slower growth forecast means that those profits might not be as big in the first place. Some investors would probably have preferred it if the Fed had left its economic growth forecasts unchanged – and instead did what it could to help the US get there by increasing rates even less next year (or perhaps not at all).

The bigger picture: Independence day.

Most major central banks are deliberately independent of governments. Investors might therefore have been really rattled if the US president’s recent pressure on the Federal Reserve to stop increasing interest rates had worked. Earlier this year, Turkey’s president made similar demands of that country’s own central bank, pushing for lower rates despite high inflation making a raise the obvious choice. Small but significant shows of defiance by both central banks have ensured neither president’s got their way.

Originally posted as part of the Finimize daily email.

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