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U.S. Interest Rates Rise... Again

The Federal Reserve ('The Fed') increased its interest rate by 0.75%.


This increase has reinforced their hawkish stance when it comes to tackling inflation. The U.S.'s historically high inflation rate currently sits at 8.26% and stands as a beast that The Fed is consistently attempting to tackle head-on. It is becoming consensus that The Fed will continue raising interest rates to at least 4% to combat inflation.


Source: Reuters

Currently, the two-year Treasury yield sits at 4.098% (up from 3.987%) and the 10-year yield sits at 3.601% (up from 3.987%) (WSJ, 2022). These yields have placed more pressure on the U.S. equity markets as investors are wary that increased interest rates dampen economic activity and thereby economic growth.


The preferability of bonds to U.S. equities places America in a unique situation. Indeed, with U.S. bonds offering higher returns than U.S. equities, we can expect investors to turn to investing in bonds. The Wall Street Journal claims that fewer than 16% of S&P 500 stocks have dividend yields greater than the yield of the two-year U.S. Treasury notes (Reuters, 2022). Accordingly, investors can expect the U.S. markets to continue to tick down as interest rates and higher bond prices force investors to turn a cheek to equities.


The situation is already beginning to play out as the S&P 500 has fallen 3.00% in the past month. While The Fed recognises the pain they are causing to businesses, households, and individuals, they are only concerned with tackling inflation and all the economic troubles it brings. As such, their hawkish viewpoint will remain persistent until they reach 2% inflation as Powell noted that "we must get inflation behind us" (The New York Times, 2022).


Global markets remain down as global bond yields reset higher. ASX futures were down 0.26%, Hang Seng is down 1.61%, and Borsa Italiana was trading down 3.28%. As already emphasised, global exchanges are trading down as central banks one-up each other, raising rates and taking aggressive actions. In response to interest rate rises, Japan intervened in their FOREX market to sell dollars and buy yen. This action has not been done since 1998 and is specifically executed to strengthen the Japanese dollar and spark demand for its currency.


The general downtick of the market in response to the interest rate increases is clear. How many more interest rate increases will occur, and when the target inflation will be reached is anyone's guess. However, what is certain is that we are living in a unique monetary environment that is bound to test all economic actors.

 

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