I’ve talked about the end of the easy money era in October, and the latest Federal Reserve’s so-called “dot plot” appears to confirm this as it shows that officials expect to raise the fed fund rates by three times in 2022, followed by another three rate hikes in 2023. The US Fed uses the “dot plot” to signal its outlook for the path of interest rates to investors, based on the median projections.
The new rate projections forecasted after the December meeting marks a significant shift from the last meeting in September. Based on the latest projection, the US fed fund rates is expected to rise to 0.9% by the end of 2022 from its current near-zero level. It is then expected to climb to 1.6% in 2023 and 2.1% in 2024.
The Fed has also announced that it would double the pace of its tapering, putting it on track to conclude the purchase of Treasuries and mortgage-backed securities (MBS) in early 2022. Until recently, the US Fed had been buying USD120 billion of Treasuries and MBS each month to help drive economic recovery.
The big pivot to a more hawkish stance by the US Fed is mainly due to the inflation development that we have seen over the last few months. Prior to this, the central bank has been calling inflation as “transitory” but the Fed Chairman, Jerome Powell, has now called inflation as the big threat for the US to get back to maximum employment.
How will the Fed Decisions Affect the Stock Market?
Most investors including myself, have been anticipating a gradual rate hike as what the “dot plot” shows, but the normalising of the monetary policy is bound to trigger some sort of volatility in the market especially since all of us have been living with low interest rate environment for quite a while.
Here is how I think the Fed’s decision would have an impact on the stock market over the next few months, pending changes in the external environment including the development of the pandemic.
In the near-term, heightened volatility is inevitable as investors and traders try to assess the impact of the US Fed’s normalising path (rate hikes and tapering of the bond purchase). This would lead to the fluctuation of the share prices in the near-term.
However, since the Fed’s decision is broadly in line with investors’ expectations and is now out of the way, there won’t be any macro uncertainties that would deny a Santa Claus rally in the US stock market.
Going into 2022, we could witness valuation for technology stocks being adversely affected, with more investors shifting towards cyclical stocks. Cyclical stocks are typically companies that sell discretionary items and services such as restaurants, hotel chains, furniture, airlines, high-end clothing retailers, automotive manufactures, which usually benefit from a booming economy.
The signal to hike policy rates in US would also be negative for emerging markets, especially from a debt perspective. A higher interest rates in US and a stronger dollar could weigh on fund flows to emerging markets.