The Federal Reserve’s interest rate announcement last week was in line with early market forecasts, but the morning after it looked like a nightmare that investors would rather forget. The Fed raised the interest rate by 0.5% – the highest interest rate increase in twenty years. If you look at the market response, it is not enough to curb inflation, which reached 8.5% last March.
Much water has flowed in the river since the Fed changed its policy 180 degrees. From his position that inflation is temporary due to corona disruptions to the recognition last November that the “temporary” notion of inflation should be abandoned, and action should be taken to raise interest rates to curb it. But market economists assume that the Fed changed policy too late, and meanwhile inflation has escaped its control.
The Fed’s trap lies in trying to find the level of “neutral interest rates” that will curb inflation on the one hand but not hurt growth on the other. Inflationary pressures are expected to be affected by the war in Ukraine leading to rising commodity prices. Beyond that, inflationary pressures can also be pointed out from the labor market in the United States. The cost of a unit of labor rose in the first quarter at the highest rate since the 1970s and with it rose fears of an “inflationary spiral”. Rise.
At the press conference after the interest rate announcement, Fed Chairman Jerome Powell ruled out the possibility that members of the Fed’s Open Market Committee (FOMC) would discuss raising the interest rate to 0.75% – which is considered abnormal compared to 0.25%, as central banks usually do when raising In doing so, Powell gave a “gift” to investors who feared too soon a tightening of the policy, and in response the leading New York indices soared sharply. The S&P 500 completed a consecutive week of declines, and the Nasdaq index completed a 24% drop from its peak.
Not black swan, but known risks
It’s hard to explain extreme declines as seen last weekend and reminiscent of the pre-crisis days of the 2008 subprime crisis. But this time it is not a black swan but a known risk. Although Powell’s tone was less hawkish than expected, investors internalized that major risk factors – such as high inflation, uncertainty about the war in Ukraine, and the development of the corona in China – were each in themselves sufficient to pose a significant threat to the economy. The reason for the sharp declines on Friday can be attributed to the fact that investors are not buying the Fed’s management expectations, and the “gift” they received in the form of neutralizing the fear of a higher rate of interest rate hikes will be shaky later in trying to moderate inflation.
Evidence of this can be found in the market that an increase in the interest rate is actually priced at 0.75%, contrary to Powell’s statements. If before the Fed’s interest rate announcement investors feared raising interest rates too fast to curb inflation, it seems that after that investors do not believe the Fed will be able to steer the US economy to a soft landing, i.e. curb inflation without bringing about a slowdown.
Along with the declines in the financial markets, there has been a jump in the long-term bond yields of the US government for 10 years, above 3%. The bond market, which competes with the heart of the stock market investor, now looks more attractive given the jump in returns that may be a better investment if locked in for 10 years given the uncertainty in the global economy. The extreme volatility of the stock market.
Demand for the dollar rose, the shekel weakened sharply
Along with the sharp declines in New York markets, the shekel weakened amid a shortage of dollars in the domestic market. The shekel has weakened sharply against the dollar since the beginning of the year – the dollar is gaining strength due to being a haven during a crisis, and apart from rising inflation in the US, the US currency strengthened against the Ukraine invasion that led to a sharp jump in global economic uncertainty
The expectation of a restraint in inflation also led to an expectation of interest rate hikes in the United States, and thus the dollar, which enjoys interest rate differentials vis-à-vis Israel, strengthens at the expense of the shekel. The shekel, because while the institutional investment overseas loses a battle alongside the declines in the markets, the institutions have to buy dollars in the domestic market against the declines, in order to meet the conditions of the investment policy. The dollar to a level of 3.4 shekels.