Back to top

Image: Bigstock

Will Bad News Turn Good for Investors in Fed's March FOMC?

Read MoreHide Full Article

Wall Street has been witnessing extreme volatility and a sharp correction in the valuation of equities in the past year. Inflation remains highly elevated despite declining from a 40-year high in June.

Over the past year, most of the economic data has stayed resilient indicating solid fundamentals of the U.S. economy. Good economic data turned bad for investors as it forced the Fed to raise the benchmark interest rate by a massive 4.5% from March 2022 to February 2023.

However, the entire landscape has changed dramatically this month as an aggressive interest rate hike by central bankers globally started affecting the banking sector. In the United States, the two major reginal banks, namely, Silicon Valley Bank and Signature Bank collapsed. Another regional bank, First Republic Bank (FRC), is currently surviving on life support.

In Europe, Credit Swiss (CS) is facing an existential threat after it failed to raise fresh funds, rattling the global financial markets. The future of the second largest Swiss lender is still uncertain despite getting financial assistance from the nation’s central bank.

At present, the banking sector — popularly known as the engine of economic growth — is at a crossroads across the world. Here lies the question — will this bad news turn good for market participants at the Fed’s next FOMC meeting on Mar 21-22?

All Eyes on Fed’s Next Move

Banks worldwide are facing a liquidity crunch as corporate clients and high-net worth individuals are rapidly withdrawing their deposits since other sources of funds (like IPO, private investment, venture capital etc.) have dried up owing to the higher interest rate regime. The Fed Fund rate is currently in the range of 4.50% to 4.75%, its highest since late 2007.

In order to raise funds, banks have to offer higher deposit rates, which would raise their cost of funds. On the other hand, a higher lending rate is forcing businesses to curtail their capital expenditure. Particularly, small and mid-sized companies are delaying (if not completely abandoning) their project expansion and infrastructure development plans. Consequently, demand for loans has dropped.

At this juncture, the outcome of the Fed’s March FOMC meeting will be crucial. The central bank reduced the magnitude of the interest rate hike to 25 basis points in the February FOMC following a gradual decline in several inflation measures in the last three months of 2022. Accordingly, Wall Street witnessed a strong pullback rally from early January to mid-February.

However, the rally evaporated after economic data showed an unexpected spike in inflation in January. A series of other key economic data also remained resilient. The labor market especially stayed rock solid. As a result, in his testimony before the U.S. Congress, Fed Chairman Jerome Powell clearly indicated that the higher interest rate regime will continue for a longer-than-expected period.

Meanwhile, the turmoil in the banking sector in the United States and Europe has shaken financial markets worldwide. The collapse of banks will significantly squeeze liquidity from the economy. It may have far-reaching consequences resulting in deep recession.

A section of economists and financial experts now expect the central bank to refrain from hiking rates in the March FOMC. Per CME FedWatch, there exists a 68% probability for a 25 basis point rate hike while a 32% probability has been assigned for maintaining the status quo. No one, is expecting a rate hike of above 25 basis points.

Bad News May Turn Good for Market Participants

A higher interest rate regime is detrimental to equity investors as it will increase the discount rate resulting in a lower net present value of stock investing. This is more important with respect to growth stocks like technology and consumer discretionary. The value of these stocks generally increases over a longer period.

The technology sector soared more than 100% in the pandemic-ridden 2020 and 2021 as the Fed kept the benchmark interest rate at almost 0%. However, in 2022, Fed’s ultra-hawkish monetary tightening with a record-high interest rate to combat inflation resulted in a sharp decline in the technology sector’s valuation.

The technology sector regained its lost momentum in 2023 as the inflation rate systematically dropped in fourth-quarter 2022 and the central bank reduced the magnitude of the rate hike in February. Thereafter, despite the threat of the continuation of a higher rate regime and the recent banking sector turmoil, the technology sector is still holding its ground.

Year to date, the Dow is down 3.9% and the S&P 500 is up just 2%. On the other hand, the tech-heavy Nasdaq Composite is up 11.1%. Of the 11 broad sectors of the S&P 500 Index, the Technology Select Sector SPDR (XLK) is the biggest gainer so far in 2023 rallying 15.3%. The Communication Services Select Sector SPDR (XLC) is the second biggest gainer climbing 14.6%. This sector is also closely linked with the technology sector.

In the past month, share prices of several technology behemoths have surged. A few of them are Meta Platforms Inc. (META - Free Report) , Microsoft Corp. (MSFT - Free Report) , Alphabet Inc. (GOOGL - Free Report) , NVIDIA Corp. (NVDA - Free Report) and Salesforce Inc. (CRM - Free Report) . These tech giants have strong potential for 2023. Consequently, north-bound movement of their stock prices is likely to continue. Meat Platforms currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

The chart below shows the price performance of the above-mentioned five tech bigwigs in the past month.

Zacks Investment Research
Image Source: Zacks Investment Research

Published in