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How do Interest Rates Affect Share Trading?

In February this year, the personal consumption expenditures (PCE) price index, which shows increases in the prices faced by consumers, had risen by a considerable 6.4% from a year before. In fact, price pressures were building to levels the US Federal Reserve was not expecting. The annual rate of their increase was three times the Fed’s 2% target rate. Contributing factors included inflated energy costs, the war inUkraine, and fatter wages. Price pressures weren’t just feeling too heavy in sectors of the economy normally impacted by the pandemic, like gasoline, furniture, used vehicles and energy. They were also weighing down the restaurant sector and the costs of car repairs. Lael Brainard, the Fed governor, was among several policymakers who are convinced that “Bringing inflation down is of paramount importance.”

Consequently, at the end of March, the news came in that the Fed had raised interest rates by a quarter of a point. America’s central bank also said that six more rate hikes could be expected in 2022. This, of course, sparked concern amongst analysts over whether all the hawkishness might send the economy into a recession or exacerbate unemployment challenges. Fed chairman Jerome Powell was optimistic on the question in mid-March, assuring his audience that it was “More likely than not that we can achieve what we call a soft landing… which is [to] get inflation back under control without a recession.” On the other hand, he admitted, “We haven’t faced this challenge in a long time.” When it comes to share trading as CFDs, keeping track of the stock market and Fed policy changes is a must, as well as projecting ahead to the potential consequences of those policy changes. For that reason, let’s take a closer look at how the chemistry of interest rates works, and try to get as clear a picture of the year to come as we can.

Interest Rate Chemistry

First, we’ll take a glimpse at how interest rates are determined. When inflation is high, as it is now, some of the unfortunate effects relate to your paycheck, which won’t buy you as much as it did before. Also, the prices of gasoline and food can tend to skyrocket. When a central bank like the US Federal Reserve raises interest rates, this may assist in getting inflation under control, but if rates remain too high, or high at the wrong time, it could spark a recession or slow down business growth to the point where people start losing their jobs.

The influence of interest rates on the economy is not straightforward, however, and other factors need to be taken into consideration. For example, if interest rates are going up and GDP (Gross Domestic Product) is going down, this is a sign the slowdown of the economy is excessive. If interest rates are going down, but GDP is up, this is good news, because it means the economy is gaining speed. Now, if the CPI (Consumer Price Index, which measures inflation) is on the up, while interest rates are falling, high inflation would be on the horizon. Finally, if (as we are hoping) the rise of interest rates brings the CPI downward, it’s good news again because it means the economy is headed toward stable territory.

Powell’s Experiment

Brainard believes inflation may rise further in the immediate future since the war in Ukraine looks set to keep pushing up food and gasoline prices. On top of that, supply chains were being squeezed in March and April by Covid lockdowns in China. She also believes that the situation in the US may not be that bleak because the economy is running on a certain amount of momentum; unemployment was low at 3.6% in early April, and the labor market was looking good. Some Fed officials have said they think the flow of workers expected to come back into the labor market may help ward off a recession by taking off the pressure employers feel to raise wages. Adding to the optimism is San Francisco Fed Bank President Mary Daly, who announced, “I’m not expecting that we’ll fall into a recession.”

Deutsche Bank takes a different view, however, and expects Powell’s moves to bring on a recession next year. They believe Powell will raise rates by 50 basis points at the next three Fed meetings, and that the Fed will reduce its bond holdings from $8.9 trillion to $2 trillion by the end of 2023. The effect will be, in their opinion, a jump in unemployment to 4.9% by 2024. In other words: stock market volatility may be rife in the months ahead.

What’s Next?

Share trading as CFDs is never straightforward at the best of times, as the stock market is influenced by so many dynamic factors. In this case, it’s doubly complicated to consider the effects of these rate hikes down the line and the analysts don’t see eye-to-eye on the question. As to the Fed’s view on things, they expect inflation to go from 4.1% this year to 2.7% in 2023, and then 2.3% in 2024. Therefore, if CFD share trading is on your horizon, it’s best to follow stock market news as well as Economic Calendar updates at iFOREX to make more informed trading decisions.

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