Weekly thoughts #10
Fed Fund Rates and their effects.
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The Fed announced last Wednesday a considerable slowdown in the path of rate cuts.
Jerome Powell said:
“We are in a new phase of the process,”
That new phase implies rate reductions less frequent.
While lower rates can offer a boost to the economy, they can also offer more fuel for inflation.
Thus, Powell caution about “further cuts” sent stocks diving.
The S&P 500 fell 2.95 percent.
How interest rates affect stocks prices?
The Federal Reserve influences the federal funds rate to control inflation decreasing the money supply by increasing the federal funds rate and increasing the money supply when it decreases the federal funds rate.
When the Federal Reserve acts to increase the discount rate, it immediately elevates short-term borrowing costs for financial institutions.
Risk Free Rate.
Thus, when the Fed hikes interest rates, the Risk-Free Rate immediately increases, which raises the company's WACC through an increase in Cost of Equity.
WACC is commonly accepted by the industry in order to discount future cash flows, which impacts stock valuation.
Investors may consider a switch to other assets less risky to shield against the risk.
Macro trends tend to be quite unpredictable by nature and generate a lot of noise that can distract us from the main focus. However, we cannot completely ignore them.
Rate markets, could be a recipe for considering in portfolio allocation process.
The macro environment has an influence in the theoretical valuation, but in the practice the correlation is diffuse.
The next investment thesis will be published next Tuesday. December 31, 2024.
