The US Federal Reserve will be announcing a rate hike decision today September 21. The Fed rate hike news may have been discounted by the stock market but the volatility may increase if the Fed throws up a surprise move. The market expects a 75 basis points rate hike and hence any surprise by Fed may spook the markets. A 75 basis point hike, if it goes through, will be the third consecutive rate hike of this magnitude.
A higher interest rate scenario has direct implications on the stock market. In an economy battling high inflation, the purchasing power of money gets reduced. The demand for goods and services falls and so do the corporate profits leading to reduced earnings. The investors, therefore, start valuing firms at a lower multiple as the growth rate of earnings falls.
Here’s how rising rates impact stock valuations – Because future cash flow is discounted at a higher rate when interest rates are higher, future discounted valuations are likewise lower.
As the August inflation data appeared higher than expected, the US Fed is expected to remain aggressive in its approach to tame inflation. The rising interest rate scenario also poses a threat to US stock market investors. Billionaire investor Ray Dalio has recently warned of a meltdown of 20% in equities if rates rise to around 4.5%. And, many analysts and economists have already warned of a US recession in 2023 given the impact of rate hikes in suppressing growth.
The Fed is expected to be more hawkish than it was in the June meeting when it also came out with its projections. With a more aggressive stance, the Fed also risks weakening the economy which may slide towards a recessionary environment sometime in early 2023.
The US stock market crash of 2022 comes on the back of the bull market rally that started around April 2020. The era of easy liquidity is over now and the 225 bps rate hike that Fed has delivered so far has brought the valuations of several top US stocks down. S&P 500 and Nasdaq 100 are already down by over 20% since January 2022. Will the markets continue to slide or take a breather before reversing direction remains to be seen.