To tame inflation, Fed raises key interest rate
The Federal Reserve intensified its drive to curb the worst inflation in 40 years by raising its benchmark short-term interest rate by a sizable half-percentage point. (May 4)
Stocks took a complete 180-degree turn on Thursday.
The Dow Jones Industrial Average and Nasdaq Composite suffered the worst one-day losses since 2020. The tech-heavy Nasdaq plunged by nearly 5% to finish at 12,317.69, its lowest close since November 2020. The Dow shed 1,006 points, or 3% and the S&P 500 shed 4%
One day prior, the Dow and S&P 500 experienced their biggest one-day gains since 2020.
This extreme swing came after the Fed increased its benchmark interest rate by 50 basis points, a move that was widely expected. Investors celebrated when Fed Chairman Jerome Powell said that the central bank was “not actively considering” increasing rates by more than 50 basis points in future meetings.
Expect more volatility
If you have whiplash from the last two days of trading, hold on tight because analysts expect more of the same ahead.
“We expect continued bouts of volatility associated with both monetary policy and the trajectory of inflation and economic growth,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “Expectations looking ahead are for another deceleration in growth in the second quarter, as well as a likely long-awaited hit to profit margins.”
To prepare for the ride, she recommends being strategic, diversified and focused on high-quality stocks with good stories and strong balance sheets, among other things.
What’s behind the change?
Just like stocks, the Fed also took a 180-degree turn from keeping interest rates at near-zero levels since the start of the pandemic to raising rates by the largest amount in more than two decades on Wednesday.
This comes as inflation is at a 40-year high. Powell has acknowledged that the Fed should have raised rates sooner to prevent inflation from growing but now the only option is to play the best game with the cards they’ve been dealt.
For the Fed, that means aggressively hiking interest rates going forward as opposed to taking a more gradual approach. But doing so could put the brakes on the economy too fast and fuel a recession. Raising rates slows the economy by making borrowing more expensive for consumers and businesses which should lead to less spending.
“The stock market was irrationally exuberant yesterday when it rallied sharply just because Chairman Powell temporarily ruled out a 0.75% interest rate increase,” said Chris Zaccarelli, chief investment officer at Independent Advisor Alliance.
“When the Fed raises rates quickly, it is dangerous to the stock market and today, we are seeing an example of that,” he added in a note.
Wednesday’s rally was “absurd considering it is predicated upon a central banker who has been completely wrong for the past 18 months stating there is a “plausible path” to a “soft or softish landing,” wrote Mike O’Rourke, chief market strategist at JonesTrading, in a commentary. “How can investors be excited now that every rally financial assets have will soon be followed by another round of interest rate hikes.”
Tech stocks led sell-off
With aggressive rate hikes in the cards, tech stocks – often seen as growth stocks – fared the worst Thursday because they tend to rely more on low rates to fuel future earnings.
Weak earnings also didn’t help. Pandemic e-commerce darlings like Wayfair, Etsy, eBay and Shopify all reported either lackluster earnings or provided lowered guidance.
Twitter, though, bucked the trend and inched up on news its Tesla Chief Executive Officer Elon Musk had secured $7 billion in financing from investors for his deal to buy Twitter at $54.20 per share.
Oil prices also stoking inflation fears
Oil prices jumped to about a six-week high on supply worries and fueled worries inflation will continue to run hot.
Elevated oil prices fuel inflation for consumers and businesses. Oil makes up half of gas prices and touches almost everything in the economy – either in producing or transporting goods closer to consumers as well as in just everyday driving. The average price for a gallon of regular gas has risen a nickel since Monday to $4.24, according to AAA.
On Thursday, the Organization of the Petroleum Exporting Countries, or OPEC, said it would stick to a previously-agreed plan to slowly increase production. OPEC said it would increase collective output by 432,000 barrels per day, starting next month, to continue unwinding production cuts first put in place in April 2020.
Meanwhile, the European Union is proposing to ban Russian oil imports within six months, while refined product imports would be prohibited by the end of 2022. Although it’s unclear if the plan will be approved, “crude prices will likely remain volatile amid the news that supply could get tighter if the ban is implemented,” according to AAA.
Elisabeth Buchwald is a personal finance and markets correspondent for USA TODAY. You can follow her on Twitter @BuchElisabeth and sign up for our Daily Money newsletter here