Today the penultimate meeting of the year of the Federal Open Market Committee (FOMC). The FOMC is the committee of the American Central Bank (FED) that decides the short-term interest rate in the United States, the so-called Fed Funds. The 0.75% increase was already expected by the market. The surprise came at the conference held shortly after the announcement. I explain below the main points and how you should change your portfolio.
The basic interest rate in the US started to rise in March of this year and since then, it has risen six times.
As with our Central Bank when it realized that inflation here in Brazil was out of control, the Fed also accelerated the rise in the last four meetings.
As can be seen in the table below, the interest rate hike in the US this year amounts to 3.75%.
Comparatively, the last bullish cycle in the US took place between December 2015 and December 2018. In three years, the Fed rose 2.25%, ending the bullish cycle at a rate of 2.5% per year.
Not only is the intensity now being higher, but also the speed.
This does not happen by accident. Current inflation in the US is the highest in forty years.
The current interest rate is compared to that of 2005. Between June 2004 and June 2005, that is, in two years, the FED raised interest rates from 1.25% to 5.25%, that is, an increase of 4 %.
The variation in this cycle of high interest rates will be greater, but the problem with the inflation scenario is now worse than in 2005.
The graph above shows the evolution of US inflation over the last 40 years. In 2005, inflation measured by the CPI, equivalent to our IPCA, was half of what is currently observed.
Shortly after the announcement and release of the announcement about the rise, the American stock market started a significant rise. This is because the communiqué implied that the Fed could already reduce the increases at the next December meeting.
However, at the conference, Jerome Powell cooled the market’s spirits. Not only did he leave room for a new high of 0.75%, but he confessed that the inflation scenario is worse than expected and interest rates may rise above what was previously expected.
Shortly after this conference, the S&P500 dropped 2.5%. It seems like a lot, but the short-term devaluation trend should not stop.
The risk and long-term fixed income markets are the most affected in high interest rate cycles. When I mention market risk, I mean stocks, gold and crypto. Therefore, it is recommended to reduce exposure to these risky assets in the US.
As I wrote last month, some analysts estimate that the S&P500 could drop below 3,000 points in the next 12 months.
Another effect of a stronger-than-expected interest rate hike in the US is greater pressure for the Real to depreciate against the dollar.
Therefore, assess your exposure to risk and fixed income markets in the US. The valuation horizon of investments in a rising interest rate market should be extended to a longer term to avoid frustration with short-term declines.
Michael Viriato is an investment advisor and founding partner of Investor’s House
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