The Impact of the Federal Reserve on the Stock Markets.

At an economic policy symposium in Jackson Hole, Wyoming, Federal Reserve Chair Jerome Powell said, “Price stability is the responsibility of the Federal Reserve and serves as the bedrock of our economy. Without price stability, the economy does not work for anyone. In particular, without price stability, we will not achieve a sustained period of strong labor market conditions that benefit all.”¹

For the Federal Reserve Chair, this was a strongly worded statement signaling the importance of controlling inflation and the continued policy of raising interest rates. Since those remarks on August 26, 2022, the stock markets have seen more volatile swings, down initially and then with some modest gains to end last week.

At Prato Capital, we normally don’t comment on short-term stock market moves but keep our comments and articles focused on trends that may affect returns over a longer period. This is in line with the focus of our clients and their long-term financial goals. But it is always important to look at the underlying issues causing any volatility. Just because we don’t always comment on short-term issues, we are still looking at them.

Interest Rates and Inflation

There are many different opinions about what impact rising interest rates will have on inflation and ultimately on economic growth.

The idea of raising interest rates to slow inflation starts with making borrowing more expensive and trying to slow spending. As an example, when the overall cost of a car loan increases, many individuals will reconsider purchasing that new car. The same is true for business. There comes a point where it is just too expensive to borrow funds for capital expenditures. As spending slows, so does the demand for goods and the theory is this will slow the rate of inflation. It will also slow economic growth and could risk a possible recession here in the US.

Like any group of individuals, economists have many different viewpoints on the impact interest rates will have on inflation and overall economic growth. Although the simplified version explained in the previous paragraph is the basis of many economic theories, discussions can become heated when the impact on the economy is discussed. Many other factors are involved when discussing interest rate hikes, inflation, and economic growth. Unemployment rates, consumer cash and debt levels, wages, and business balance sheets are just a few of the economic variables that are considered in these discussions.

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