Stock Market Volatility and Fed Rate Cuts
The markets have seen a significant shift in direction since the start of April. From January through March 2024, investors saw a steady climb in the S&P 500, which increased 10.6%. In the first 10 days of April, however, the index decreased approximately 2%, falling in four out of eight trading days. What’s driving this decline and why such a departure from the first quarter? The simple answer is… investors’ changing expectations for Fed interest rate cuts.
Connection Between Interest Rates and Inflation
Over the past 16 months, the Federal Reserve has been raising interest rates in order to combat inflation after the COVID lockdown ended in 2021. Short-term interest rates went from 0.25% at the beginning of 2022 to its current rate of 5.25%, a whopping 5% increase in a very short period of time.
Source: Adams, Michael. “Federal Funds Rate History 1990 to 2023”. Forbes Advisor, March 21, 2024, https://www.forbes.com/advisor/investing/fed-funds-rate-history/
By raising interest rates, the Fed hoped to dampen consumer purchases as higher rates on credit cards, cars and home loans as well as higher prices in general should cause consumers to spend less and, thus, bring down inflation.
Is It Working? Yes, Sort of…
Inflation reached a recent high of 9% in June 2022 and has steadily declined to 3.5% in March 2024, so the Fed’s actions seem to be working. Inflation is TRENDING is in the right direction, however, the rate of change is the problem. Investors expected inflation to drop more quickly, which would lead the Fed to start lowering interest rates and – lower rates means higher stock prices. Investors were caught off guard today when March's inflation rate came in at 3.5%.
Roller-Coaster of Expectations
Expectations play an important role in market activities, and negative surprises are not welcomed. As inflation remains higher than anticipated, expectations of when and how much the Fed will lower interest rates keep changing. At the beginning of 2024, the market expected the Fed to cut rate four to seven times, leading to investor exuberance and the S&P 500’s 10% gain through March. In the present environment, investors are only expecting two interest rate cuts this year, which is why stocks are less appealing. This roller-coaster ride of expectations will result in increased volatility through the rest of the quarter and likely throughout the year.
Investment Implications
How should long-term investors view the current market volatility? You guessed it…it’s just noise. In times of uncertainty, markets become volatile, and this includes expectations relating to the Federal Reserve actions. Short-term investors might benefit from market noise, but long-term investors are best served to ignore it as market swings caused by short-term sentiments do not affect a portfolio's underlying value.
Pamela Chen is the Founder and Chief Investment Officer of Refresh Investments LLC, a fee-only financial planning and investment management firm with locations in Santa Monica and San Diego, CA serving clients throughout Southern California and the United States.
The information provided in this article is for informational purposes only and should not be considered investment advice. There is a risk of loss from investments in securities, including the risk of loss of principal. The information contained herein reflects Refresh Investment’s views as of the date of this presentation. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. Refresh Investments does not provide tax or legal advice. To the extent that any material herein concerns tax or legal matters, such information is not intended to be solely relied upon nor used for the purpose of making tax and/or legal decisions without first seeking independent advice from a tax and/or legal professional. Refresh Investments has obtained the information provided herein from various third party sources believed to be reliable but such information is not guaranteed. Certain links in this site connect to other Web Sites maintained by third parties over whom Refresh Investments has no control. Refresh Investments makes no representations as to the accuracy or any other aspect of information contained in other Web Sites. Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Refresh Investments is not responsible for the consequences of any decisions or actions taken as a result of information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of Refresh Investments.
