In line with expectations, the Federal Reserve increased interest rates to their highest level in over two decades, causing stocks to stabilize on Wednesday.
The S&P 500 remained close to a 15-month high, showing a marginal decline of 0.1% or 0.71 points, settling at 4,566.75. Meanwhile, the Dow Jones Industrial Average experienced a modest increase of 0.2% or 82.05 points, closing at 35,520.12. The Nasdaq composite saw a slight dip of 0.1% or 17.27 points, ending at 14,127.29.
Following the announcement, the bond market reacted more significantly, leading to a drop in Treasury yields. Federal Reserve Chair Jerome Powell’s remarks indicated that no final decision had been made on whether to raise rates further in the upcoming meetings or beyond, fostering optimism among traders that the recent rate hike might mark the end of rate increases for the foreseeable future.
Despite Microsoft reporting better-than-expected profit and revenue for the spring, the company’s stock fell 3.8%, significantly impacting the market. Analysts attributed this decline to Microsoft’s comments, which seemed aimed at managing overly optimistic expectations regarding its future growth prospects in artificial intelligence. Investors were likely eager to receive more clarity on when the slowdown in growth at Microsoft’s Azure cloud computing business would reach its lowest point (trough). The combination of these factors contributed to the negative sentiment surrounding the company’s stock performance on the market.
Alphabet, the parent company of Google and YouTube, played a crucial role in limiting the market’s losses as its stock surged by 5.6%. This boost came after Alphabet reported better-than-expected profit and revenue for the spring, outperforming analyst estimates.
Big Tech companies hold a significant sway over Wall Street due to their enormous size and influence. Just seven of these tech giants were responsible for the majority of the S&P 500’s returns in the first half of the year, largely driven by the anticipation of their continued explosive growth. However, to justify these impressive gains, they will need to deliver substantial profits.
One of these influential players, Meta Platforms (formerly known as Facebook), also reported its results after the day’s trading had closed. The stock has already surged by 148% this year, while Alphabet and Microsoft have also shown notable gains of more than 40%.
In contrast to the S&P 500, the Dow Jones Industrial Average is less focused on Big Tech. Boeing, an aircraft manufacturer, played a role in shoring up the Dow as its stock climbed by 8.7%. Boeing reported a smaller loss for the spring than analysts had anticipated, and its revenue exceeded expectations.
In the bond market, the Federal Reserve’s decision to raise its federal funds rate to a range of 5.25% to 5.50% was the major highlight, aimed at addressing the issue of high inflation. This move marked the highest interest rate level since 2001, a substantial increase from the near-zero rates implemented early last year.
Traders are optimistic that this rate hike could potentially be the last one in this particular cycle, mainly due to the fact that inflation has been trending downward since the previous summer. This hope has been a significant driving force behind the remarkable rally on Wall Street throughout the year. The rationale is that rate hikes work to reduce inflation by putting pressure on the entire economy, which, in turn, increases the risk of a recession and negatively impacts investment prices.
So far, the economy has defied expectations of a recession, largely due to a robust job market that has allowed American households to continue spending. This has led to increasing hopes that the Federal Reserve can orchestrate a “soft landing” for the economy, where high inflation gradually returns to its target without triggering a painful recession.
However, some critics argue that traders might have embraced these optimistic expectations too hastily and too strongly. Despite a decline, inflation remains elevated, and the Federal Reserve may need to maintain higher interest rates for a considerable period to bring it down to the desired 2% target. They caution that the risk of a recession still looms, making the current optimistic scenario potentially inconsistent and precarious.
Sameer Samana, senior global market strategist at Wells Fargo Investment Institute, expresses concerns that the market might be constructing an internally inconsistent narrative, where growth appears to be stable, inflation seems to be under control, and the Federal Reserve can start reducing interest rates. Such a scenario might be overly optimistic and may not align with the actual economic conditions.
According to Sameer Samana, a resilient economy may lead to elevated inflation, and there is a possibility that inflation could pick up speed again later in the year. Prices for commodities like oil might end up higher than they were a year before, contributing to the inflationary pressure.
Samana believes that the current situation is the “easy” part for the Federal Reserve in terms of managing inflation. However, going forward, inflation is expected to be more stubborn and challenging to control.
Federal Reserve Chair Jerome Powell mentioned that interest rates will likely need to remain high for a considerable duration to effectively combat inflation. However, he did not commit to the possibility of further rate increases. The Fed will have its next opportunity to raise rates at the September meeting, but Powell emphasized the importance of gathering more data on inflation and the job market before making any decisions.
The yield on the 10-year Treasury, which influences rates for essential loans such as mortgages, slightly declined to 3.86% from 3.89% on the previous day. The bond market is closely monitored as it provides crucial insights into the overall economic conditions and investor sentiment.
Overall, uncertainties surrounding inflation and the economic outlook warrant careful consideration, and the Federal Reserve remains data-dependent before making any further monetary policy adjustments.
The two-year Treasury yield, which is particularly sensitive to expectations regarding the Federal Reserve’s actions, declined to 4.85% from 4.88% after Federal Reserve Chair Jerome Powell’s remarks. Prior to Powell’s speech, the yield had been at 4.91%.
In European markets, stocks experienced more substantial declines. France’s CAC 40 index dropped by 1.4%, while Germany’s DAX index lost 0.5%.
Asian markets also faced downward pressure, with South Korea’s Kospi index falling by 1.7%, and Japan’s Nikkei 225 index remaining nearly flat. In China, stocks saw a modest decline as traders awaited further information on how the ruling Communist Party plans to boost the country’s sluggish economic growth. Although the ruling party has pledged support for entrepreneurs and the struggling real estate sector, specific details on their plans have not been disclosed yet, leading to cautiousness among investors.