Market Commentaries

USD Federal Open Market Committee Rate Decision Rules Today’s Financial News

2016-03-07-1457373403-2971233-cd_interest_rates The U.S. key interest rate is expected to increase today, which changes a lot of things. The day we have been expecting in the financial and capital markets for a long time has finally arrived. The USD Federal Open Market Committee Rate Decision is today. The expectation is for the Fed to increase the key interest rate from 0.50% to 0.75%. So, with more expensive money and capital, what are the financial effects? We’ll start with the following point of view, from an interview with CNBC’s Squawk Box on Tuesday morning. The Microsoft founder said that low-interest rates have allowed stocks to get expensive. “Well, certainly, stocks are expensive,” said Bill Gates. “But it’s all in relationship to the macroeconomic picture, which I’m certainly not an expert on, and I find, you know, kind of amazing that interest rates have stayed so low for so long.” Gates then said in the interview that the main reason that stocks are so high is “because of the interest rate environment.” So if low-interest rates are good for the growth of the economy, what will happen if the expectation of rising interest rates becomes a reality? Fear has possibly given way to greed and overly optimistic expectations in the stock markets, as the U.S. stock market has made an impressive rally without any significant correction for over one month since the outcome of the election. The Dow is very close to 20,000, and many stock prices have soared, even some stocks with poor financial performance or losses. All of this is irrational, and certainly not healthy for the stock market. As interest rates are increased, the stock market has to review the basic fundamental principles of finance. There is an inverse relationship between higher interest rates and the true intrinsic value of any stock in a discounted cash flow analysis valuation. Even small changes to major key assumptions, such as interest rates for the cost of an equity, can lead to big changes in the valuation of stocks. At some point, the stock market has to take a deep breath and ask, “Is this rally sustainable, and if yes, who will continue to buy at higher levels? What are the areas of support where attractive valuation will be apparent? Why should someone buy a stock with losses, or very poor fundamental metrics other than very optimistic expectations?” Expectations versus logic and reality. Today’s Fed decision on a key interest rate, and the following months will be interesting to watch and analyze.