Tonight it will be announced whether the Fed, the US central bank, will raise official interest rates faster than expected.
Spend less money
It is important for the Fed to operate cautiously and not to scare investors, according to RTL Z stock exchange commentator Durk Veenstra. If investors fear that interest rates will be raised much more than they previously thought, it could mean that they fear that consumers will spend less money, causing the economy to take a hit and possibly end up in a recession, Veenstra said. And that will hit corporate profits again.
Investors believe that inflation will drop in the somewhat longer term, so that there is not much need to go very fast, according to Veenstra. But of course you never know.
In November, American consumers paid 6.8 percent more for a basket of groceries than a year earlier. That is the largest increase since 1982. Prices also rose in the eurozone, by 4.9 percent in November. This means that inflation is much higher than in recent years.
This is not only annoying for consumers, because they pay more dollars or euros for the same products, but it can also have serious consequences for investors.
It is somewhat questionable whether the higher inflation is temporary or will last longer. If inflation remains high for an extended period of time, central banks may intervene.
After all, their job is to keep inflation from getting too high. Traditionally, they fight inflation by raising official interest rates. Then there is less demand for products, which reduces inflation.
But at least not now
Now the ECB, the European Central Bank, and the Fed, the central bank in the US, are not going to raise interest rates right away. Both still buy bonds; policy that dates back to the time when inflation was still far too low. The ECB and the Fed will first stop their buying policy before raising official interest rates.
The Fed seems to want to phase out its asset purchase policy more quickly than expected. In principle, this means that an interest rate increase is also closer. Due to the size of the US stock market and the amount involved in US investments, developments in the US often affect the rest of the world. Tonight at 8 p.m., the Fed will announce its plans for the coming period.
Higher interest rates sometimes good, but not for many companies
For some companies, such as banks, a higher interest rate is fine. A higher interest rate increases the margin for banks on the interest they pay to savers on the one hand and the interest they can ask from companies or consumers that borrow money on the other.
For many other companies, a higher interest rate is, in general, not so nice. For example, a higher interest rate can slow down the economy and therefore have a negative effect on company profit. Furthermore, in principle, the price of a share is the present value of future profits. So you are going to calculate the profits that you expect in the coming years back to now.
To give an example: with an interest rate of 0 percent, the value of a profit of 100 euros that you book in ten years is now also 100 euros. But if the interest rate rises to 1 percent, the current value falls to 90.50 euros. That matters quite a bit.
Precisely because it is assumed that the profits of tech stocks will continue to grow fast, more than those of other companies, higher interest rates will hit them much harder. After all, you will recalculate all those profits at a higher interest rate.
You can see that on the American stock market. The share price of, for example, Microsoft and Tesla has fallen in recent weeks. But the price of Berkshire Hathaway, the investment vehicle of investment guru Warren Buffett, which invests much more in the ‘old economy’, has risen to a record high, RTL Z stock exchange commentator Durk Veenstra shows.
Some tech stocks have also been doing less well on the Amsterdam stock exchange lately. For example, the share price of fintech company Adyen and Just Eat Takeaway.com, the mother of Thuisbezorgd.nl, among others, has fallen. The share price of ABN Amro bank went up slightly.
If interest rates rise, it is not good for bonds you already have. After all, the interest rate is already fixed and if the official interest rate rises, you will receive a higher interest rate on new bonds that you can buy. Investors therefore prefer the new bonds and not the old ones on which they receive less interest.
Investors are already responding to this by buying special bonds, for example, where the interest you receive is adjusted to inflation. In addition to these bonds, commodities and real estate have traditionally been seen as a way to respond to higher inflation.