Opinion – Grain in Grain: FED gives short but direct message; understand how it affects investments

It was a speech of less than 9 minutes, but it caused a loss of more than US$ 1 trillion, considering only the American stock market last Friday. I explain the main messages of Fed Chairman Jerome Powell and the consequences we can expect from investments.

We can list four main messages in Powell’s speech:
1 – Fed will do everything to bring inflation back to the target of 2% per year;
2 – Price stability is the responsibility of the FED, because without price stability the economy would not function sustainably, affecting the labor market;
3 – Restoring price stability will take time and will require the use of monetary policy tools firmly. Consequently, growth will remain low for a while;
4 – Higher interest rates and slower growth will penalize businesses and this is the cost of seeking to reduce inflation.

The Federal Open Market Committee (FOMC), similar to the COPOM in Brazil, raised the basic interest rate to the range between 2.25% and 2.5% per year at the last meeting in July.

At that moment, he already raised the possibility of a further increase of 0.75% at the next meeting in September, but the market understood that it could be even less and, with the release of economic indicators that signaled lower inflation and lower growth, it was even more optimistic in this month of August.

In his speech, Powell made it clear that the next rate hike should be 0.75%, followed by eventually smaller ones. Also, that restrictive monetary policy will be maintained until inflation falls to the target. So it was more incisive.

He stressed that, at the end of 2023, the base rate would still be slightly below 4% per year, that is, with today’s data, possibly, there would be no interest rate drop until the end of 2023. The market was already counting on less interest.

This breach of expectation caused the losses in the stock markets last Friday.

After that first market scare on Friday, what concerns remain?

The Fed’s message was very clear. Interest rates will rise and remain high until inflation drops.

This is a very bitter medicine for risky assets in general. This does not mean that one should not take any risk position. However, it is necessary to consider a longer-term horizon.

The cycle of interest rate hikes in the US will depend on the next economic inflation data. The American inflation index (CPI), equivalent to the IPCA in Brazil, is released on the tenth day of each month.

If there is a faster reversal of inflation indicators, the market could improve again. Therefore, it will be necessary to monitor closely.

The assets that suffer the most from interest rate increases are those that have low short-term cash flow or simply do not have it, for example, crypto assets, gold and shares of companies with no expectation of short-term profit, such as technology. .

Also in the international market, long-term fixed-income securities should be avoided, as they are more affected at times of rising interest rates.

In Brazil, the rise in US interest rates may cause greater pressure to devaluation of the Real and negative effects on the stock markets. For Brazilian assets, the fact that the Central Bank of Brazil is more advanced in the process of raising interest rates weighs positively.

In the domestic market, possibly, the Selic may not even rise more, which is positive. However, an eventual drop in rates, which could favor the market, also depends on the cooling of domestic inflation and international interest rate movements.

Therefore, caution is still required in investments.

Read Jerome Powell’s speech in full at the link.

Michael Viriato is an investment advisor and founding partner of Investor’s House

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