The Fed hikes. Will shares fall?

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Carrington Clarke (0:36)

It was all marketized on Washington, DC overnight, and the US Federal Reserve has delivered what the money flows predicted, hiking official rates in the United States for the first time since 2023 The Fed chair, Kevin Warsh, says it's meant to help bring inflation back towards the target in a timelier manner. But is it enough or are more hikes to come? Today we'll delve into what higher rates in the United States mean for the global economy, but specifically drill down into what it means for Australian companies and your investments. Do higher US rates mean lower returns? Welcome to ABC Business Daily.

I'm Carrington Clarke.

Richard Schellbach (1:19)

And I'm Richard Schellbach, Equity Strategist from UBS Australia.

Carrington Clarke (1:23)

Richard, thank you so much for joining us on this very special day. This was what the market had anticipated. The money flow seemed pretty clear, but there had been for a while at least disagreement about economists, about whether or not the Fed would choose to do this rate hike, given it is pretty close to the midterm elections. I want to get insight into how closely you were watching this decision.

Does it change anything about what you thought was going to happen in global markets? And do you think it's likely we're going to see a further rate hike?

Richard Schellbach (1:55)

Look, that's a good point to start at, Carrington. Now, what I would point out is Fed rate decisions, whether they're moving up or down, or even on the decisions where it's unchanged, it sets the agenda for global markets. The US economy is the largest and it's the dominant economy in the world. US capital markets dominate sentiment around the world. So whatever was going to happen would be topical and would be the type of thing that somebody in my job would be solely focused on.

What it means however, in terms of the discussion around, will the Fed move or will it not?

Through an economic lens and a market analyst lens, their decision to hike was no surprise. And the reason it was no surprise is because we look at the same data points that they look at, which is in the US, growth has been strong, productivity is strong, capital investment is booming, unemployment rate is low. All these measures suggest that you have a tight or strong economy whereby policy rates need to be recalibrated somewhat upwards to therefore reign in inflation and in particular inflation expectations. So again, through the financial and economic lens, no surprise at all. Interest rate futures and for that matter, bank analysts such as myself, we continue to expect that they will therefore need to hike further over the coming 6 to 12 months.

Carrington Clarke (3:28)

So all other things being equal, the Fed hiking rates mean borrowing costs, it's more expensive to borrow.

There have been some people speculating that if we saw a run now of interest rate hikes, that could do some damage to the equity markets. It makes maybe some of these valuations start to look a little bit stretched, particularly when it comes to some of those artificial intelligence plays. Is that your read of it and do we get into potentially choppy waters if the Fed continues to hike and could we see a major pullback in the valuation of some of these companies that are linked so closely to the artificial intelligence story?

Richard Schellbach (4:08)

Look, I frame a lot of that in terms of where we are in the economic and financial credit cycle. Now, we would phrase that we're in a late cycle environment. Now, late cycle environments are characterized by capacity constraints.

Why? Because the demand out there in the economy, be it from consumers or capital investment.

Now, in this cycle, it's very much capital investment led, but that tends to happen towards the latter part of an economic cycle. So that excess of demand over supply that's a product of the investment cycle, means that inflation measures tend to move higher. It means that commodity prices tend to move higher. Therefore, with inflation expectations high, central banks have to hike to bring those inflation expectations down. So that's a normal evolution of a credit and economic cycle.