New York stock markets continue to decline at the opening of the trading week after sharp declines last weekend, with the Nasdaq completing a 25% drop from its peak, although US stock indices returned to their level from just over a year ago. Given the dreamy returns of the indices in recent years, it may have been tolerable but the extreme volatility reflects the fear that this time is different, as Fed has few tools left in the face of rising US inflation (which has already reached 8.5% a year). This year in the financial markets does not stop, investors are digesting the risks and the dilemma of the Fed: the continued rise in inflation or slipping into recession. Are we on the verge of a crisis and how are the sharp declines in US markets related to us Israelis? Here are questions and answers.
Was the raising of the US interest rate by half a percent that was announced last Wednesday by the chairman of the Central Bank, Jerome Powell, surprising?
No, the US rate hike was expected. What was surprising was Powell’s statement at the press conference that he was denying a higher rate of 0.75%. This is a rate that is considered fast and could cause a shock. It should be said that a 0.5% increase in The interest rate, as it was done last week for the first time in twenty years, is also considered exceptional, implying that the Fed will continue in a gradual upward line and not accelerate the pace.
Following Powell’s announcement of an interest rate hike, markets soared but declined. This is in addition to the fact that in recent months we have seen the Nasdaq index already 24% away from its peak and the S&P index closing for the fifth week in a row of declines. How can one understand the current storm in the markets?
One interpretation is that investors did not believe in managing the expectations led by Powell, who is trying to bring about a “soft landing” of the American economy; That is, to take control of inflation, without leading to a recession. Already the morning after the interest rate announcement, the contracts in the market expected that there would be an increase in the interest rate of 0.75% in the future. Investors have realized that a more gradual rate hike is not enough to curb inflation, and we may also see a combination of inflation and economic slowdown in the US, the so-called “stagflation”.
Modi Shafrir, Bank Hapoalim’s financial markets strategist, adds that “the storm occurred in my opinion against the background of the understanding of the markets that contrary to the trend in a decade, currently the Fed can support markets less. When the Fed raised interest rates in 2016 for example, Not to hurt the markets too much. And he could have done that, because during that period inflation was below the target, below 2%. Now inflation is the Fed’s main problem, so he is in a dilemma: on the one hand, do not hurt the markets, because they can hurt “In private consumption and the economy; and on the other hand, also to raise interest rates in a way that will be able to curb inflation. Because high inflation also harms private consumption and the economy.”
Modi Shafrir / Photo: Ilan Besor
Along with the declines in the markets, since the beginning of the year we have seen a trend of the strengthening of the dollar against the shekel and against other currencies. What is the connection between declines in the markets and the strengthening of the dollar?
The dollar is considered a safe haven during a crisis, so when the markets go down, in Ukraine there is a war and in China there are closures – the dollar goes up. Beyond that, the interest rate differentials between the United States and Israel (in Israel the interest rate is lower than in the United States) work in favor of the dollar, and accordingly the shekel weakens. Moreover, the institutional entities manage the investments overseas, and so when these go down, these entities are forced to purchase dollars for the purpose of balancing. Thus the supply of dollars in the domestic market decreases and the shekel weakens.
The US government bond market may be more interesting now because of the interest rate hikes?
According to Modi Shafrir, “Already now the nominal ten-year bond yield is over 3%, so apparently get better interest rates and less worth investing in stocks. Still, even in the bond market today investors have lost a lot of money since the beginning of the year. Although they have bought some bonds and will receive interest that they will reach maturity, but the yields in the market have gone up and the price of the bond has gone down. So right now, because of the falling prices of the bonds, whoever invested in these bonds lost money.
Does the investors’ response represent a lack of confidence in the Fed? According to Shafrir, “I do not know if I would define it as a lack of trust, but there is no doubt that the Fed came and said throughout 2021 that ‘temporary inflation, everything is fine we will not raise interest rates’ and then changed disk almost 180 degrees – it hurt its credibility and markets reacted For that.
“At the moment, US inflation expectations, looking ahead, are relatively high. The expectations for the ten years are in the 3% range, which means that the Fed has more work to do. ”
He says he does not see the development of a crisis in the US because “at the level of the real economy, the situation looks excellent. Unemployment is at a low level, there is a demand for workers, and the situation in Israel is similar. Although the official figure indicated a contraction in the first quarter of the year, the economy is still in good shape. The market’s concern is about what will happen in 2023. “The understanding that the Fed is going to raise interest rates to a restraining level, combined with rising inflation, combined with the mess in world supply chains – all of these things increase the chances that we may see a downturn in the recession.”
Shafrir also does not expect the Bank of Israel to change its plans for raising interest rates to 1.5% in a year, following what is happening in the US. “Inflation in Israel is above the 3.5% target and our estimate is that in the coming year inflation will continue to be above target. Towards the middle 2023 onwards it will moderate to the target area. At the moment, it seems that the Bank of Israel will continue to raise interest rates. ”
Shafrir expects the shekel to continue to strengthen in the long term, despite the current trend of the dollar strengthening against the shekel in the short term. “In recent years I have been in Long’s position on the shekel because of the basic forces working to strengthen the shekel, and that in my view is what will continue to happen in the long run. But this year should hold a neutral position in the foreign exchange market.
Is the current avalanche much more temporary or dramatic?
“There is no knowing, but there is no doubt that the declines now being seen in U.S. markets are a real avalanche. Is it time to get out of the market? Depends on the purpose of the investment. In long-term investments – 5-10 years and above – any crisis in the markets is a passing episode and the long-term markets are moving upwards. And keep in mind that the crisis is not due to a black swan, but because of inflation. It is the Fed’s policy that will dictate the situation in the markets and it remains to be seen whether the “market” attributed more credibility to the Fed than it currently attributes to it. ”