The Federal Open Market Committee (FOMC) kicks off its regular meeting today. Markets expect a rate hike to be announced on Wednesday. What I’m really interested in, though, is what the Fed plans to do about rates for the rest of the year, as well as how it intends to reduce its balance sheet.
Why we may see continued rate hikes
I do expect to see a rate hike tomorrow, not least because the markets expect it, but also because there seems to be a real shift in the Fed’s thinking, which has turned from worries about the risks of raising rates to worries about keeping them too low. Even the most dovish Fed members seem to have adjusted their positions recently. This says to me that the Fed is likely to keep raising rates. In fact, I would not be surprised to see language to this effect this week.
Higher rates make sense from several perspectives:
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- With rates as low as they are, the Fed has little room to cut them if the economy weakens again. So raising rates now, in advance of the next recession, makes sense.
- Financial conditions are fairly easy right now, and the economy is doing better, so why not raise rates now? It could be harder to do so in the future.
- From a statistical point of view, the Fed’s goals have largely been met. Rates should reflect that, which means raising them.
All of this suggests to me that the Fed will indeed keep raising rates for the rest of the year. The real risk here is inflation, which is trending lower again. Unless inflation drops much more than it has, though, I think the arguments above still point to a need to raise rates. We will find out soon if the Fed agrees.
Why I’m not worried about tech stocks
The same factors that will keep the Fed raising rates—economic growth and easy financial conditions—are also likely to keep supporting the stock market, which is why I am not particularly concerned about the recent pullback in tech stocks. We have seen drops in some of the most highly valued companies, and the fear is that this is the prelude to another 1999. I do have concerns about that—and I will finally pick up the discussion again tomorrow—but I don’t think it is happening right now.
Why not? Tech stocks are, in aggregate, valued roughly in line with the market as a whole on both an operating earnings basis and a cyclically adjusted basis. In other words, based on what companies are earning, tech stocks are not substantially more expensive than other stocks. Moreover, if you look at what drove up even the marquee stocks (largely, growth), there still are not any other options out there.
We may see a further pullback—perhaps even a correction in some of the most highly valued stocks—but both the sector and the market are not any more at risk than they were before the pullback earlier this week.
Big picture, both the economy and markets remain well supported. The primary risks we face are medium term—say, in the next 12–24 months—rather than immediate. I expect to see the Fed ratify these thoughts this week and for the markets to respond appropriately.
Article by Brad McMillan, Commonwealth Financial Network