This Week in Review | Fed Rate Hike, Tech Volatility & AI Risks, Bond Yields

Transcript

Hello and welcome to This Week in Review.

This weekly segment is designed to highlight a few things you may have missed this week, what they could mean for financial markets and why they matter to investors like you. To stay up to date with our latest market insights, subscribe to our YouTube channel or visit FisherInvestments.com. Now, let's review what happened this week.

First, the Fed rate hike.

On Wednesday, the Federal Reserve's policy setting committee voted unanimously to raise the Fed funds policy rate by 25 basis points. That brings the Fed's target interest rate range to 3.75% to 4%, and it marks the first hike since 2023. This move was widely expected, so most of it was largely baked into markets before the announcement. The day of the announcement, the S&P 500 fell by less than half a percent, and the two-year Treasury yield, which tends to track the Fed's policy rate expectations quite closely, just edged up slightly. These are pretty modest moves and indicate to us that investors had largely priced in the decision. What stood out a bit more was the Fed's signal of another possible rate hike later this year. Now, the main thing to keep in mind in all of this is that stocks can rise whether rates move up or down. Remember, this bull market began in October 2022 when the Fed was in the midst of a rate hike cycle. So, it's more common than you might think for stocks to keep climbing even as interest rates rise. While we believe a rate hike wasn't necessary and represents a minor headwind, it shouldn't change the positive economic trends supporting today's bull market. Yield curves across the developed world remain steep, which encourages bank lending that can help fuel economic growth. Corporate earnings have also been strong worldwide through the second quarter, and despite some budding signs of euphoria, pockets of investor skepticism remain, which suggests this bull market should have more room to run. We also expect November's US midterm elections to likely usher in more gridlock, reducing legislative uncertainty and propelling stocks forward. Monetary policy, of course, is ultimately just one of the many forces shaping the economy and driving returns. We think investors are better served by keeping their focus on the broader fundamentals moving markets.

Next, tech volatility and AI risks.

This week, the technology sector took center stage once again. Several high profile tech leaders called for slowing the pace of AI development over safety concerns. And, of course, markets took notice. Semiconductor stocks were especially volatile. Now, a slowdown in AI could mean less data center spending and, in turn, softer demand for chips. However, we caution against reading too much into one week's headlines. It's hard to tell whether an AI slowdown will actually happen, or whether this is simply just the story of the moment. So, let's take a look at the bigger picture. Yes, tech has been riding high on the AI wave, but earnings growth is very strong across sectors. Energy, communication, materials and consumer discretionary are all expected to post double digit earnings growth this year right alongside tech. So, that reminds us why diversification is vital to long-term investment success. Lean too heavily on any single sector and you might miss out on the strength elsewhere or leave yourself overly-concentrated, which adds risks you may not want. Another reminder from this week's volatility is that markets tend to move on the gap between expectations and reality. High expectations for tech firms leave less opportunity for positive surprises and open the door to sharp drops at the first sign of bad news. So, to the degree that tech sentiment cools and investors reset their expectations, it can actually create more room for markets to keep climbing the proverbial "wall of worry" that slows the progression towards rampant investor euphoria and helps this bull run keep going. Ultimately, try not to overthink short-term volatility. Weekly or even monthly swings are simply part of stocks' long-term growth. Stay focused on the road ahead, not on any single bumpy stretch in a single sector along the way.

Finally, bond yields.

This week, the US 10-year Treasury yield briefly climbed above 5%, a level that we haven't seen since 2007. Germany's 10-year bond yield rose above 3.5%, its highest level since 2009, while Japan's 10-year government bond yield hit a 30-year high above 3%. Numbers like these can look alarming at first glance, but here's some helpful context. Rates seem high because we've all grown so used to the unusually low interest rate levels that followed the Great Recession. A big reason for that was various central banks pursuing zero interest rate policies and also quantitative easing, or QE, which pushed rates lower from 2007 all the way through the pandemic. Then, starting around 2022, central banks have let policy normalize, which is part of the reason we've seen rates climb back up. But if you look further back through history, today's yields actually look pretty ordinary. For example, the 10-year US Treasury yield was at similar or higher levels throughout much of the 1980s and 1990s, without triggering a US debt crisis or preventing strong stock market returns. So, this all raises a really important point. Any single interest rate or bond yield by itself tells you only part of the story. What matters much more is the relationship or spread between short- and long-term rates. Long-term rates are set by the bond market, while short-term rates are set by central banks. And right now, the spread across US and other developed markets are positive and have actually widened this year, which is supportive of economic growth. Now, this matters because banks make money on the difference between what they pay on short-term deposits, such as interest paid on consumer savings accounts, and what they earn from long-term lending, such as business loans and mortgages. The wider the gap, the more eager banks are to lend, and lending growth provides fuel for economic growth. So, while the headlines today focus on rising yields, interest rate spreads point to continued healthy loan growth, and that's an encouraging sign for markets.

That's it for this week.

Thanks for tuning in to This Week in Review. If you're looking for more insights, don't miss our other series Three Things You Need to Know This Week, which we release every Monday. You can also visit FisherInvestments.com anytime for our latest thoughts on markets. Thanks again for joining us, and don't forget to hit Like and Subscribe.