If you happened to look at your stock portfolio over the past few days, you might have gotten a jolt.
After remaining relatively steady for weeks, all three major stock indexes took a dive Friday. What happened?
There could be several factors that had investors on edge—including news that North Korea had completed a fifth nuclear missile test and the European Central Bank had declined to announce additional measures to help stimulate Europe’s sluggish economy—but many strategists pointed to a speech Friday morning by Federal Reserve Bank of Boston President Eric Rosengren, in which he said that “a reasonable case can be made” for tightening interest rates in the U.S. The Dow Jones Industrial Index (an index that tracks 30 large, established, U.S.-based companies across all sectors) fell more than 100 points after his speech.
How can one line have such an impact on stocks?
Many analysts expected the Federal Reserve not to raise interest rates when it meets this month, but Rosengren’s comments—as well as news that the bank’s most dovish official, Lael Brainard, would be delivering a previously unannounced speech on Monday—indicated that may not be the case. “Those who [now] fear that the Fed will raise rates in September are recoiling,” says Certified Financial Planner Stacy Francis, CEO of Francis Financial in New York. “The market does not like unexpected news.”
The Federal Reserve (the country’s central bank) is meeting on September 20 and 21 to decide, among other things, whether to raise what’s called the fed funds rate: the rate at which financial institutions lend money to one another overnight. And that rate—currently set at .25 to .5 percent—influences other interest rates, including those banks offer for savings accounts and those you can get charged on credit card balances and loans.
Why would an interest rate hike affect the price of stocks?
For one, when rates are low, people are more willing to borrow money, which they use to buy products and services. That can help buoy the economy as well as company earnings, which helps boost stock prices. And when rates are low, banks offer lower interest on savings, money market accounts and certificates of deposit. For investors who are looking for the option that provides the highest rate of return, stocks can look particularly attractive when returns on other investments are lower. As of Thursday, the Dow and the S&P 500 (an index that includes 500, mostly large-cap companies) were each up about 8 percent for the year. Meanwhile, a Bankrate survey of 4,800 financial institutions found the average annual yield on a savings account was .48 percent.
“The odds are that these markets are going to continue to rise until interest rates rise meaningfully,” Tim Courtney, CIO of Exencial Wealth Advisors in Oklahoma City, told Grow in August.
That’s not expected to happen this month, even if the Fed votes to raise rates.
On Friday, the CME FedWatch Tool, which is based on the CME Group 30-Day Fed Fund futures prices, showed a 73 percent chance that the Fed would raise rates just 25-50 basis points, if it voted to raise rates. That would put the range at .50 to .75 percent, still near historic lows.
It’s also important to remember during dips like the one on Friday that market fluctuations are not unusual. And, historically, the market has recovered from past downturns, and then some.
In the days that immediately followed the United Kingdom’s decision on June 23 to leave the European Union (a.k.a. “Brexit“), for example, the Dow fell nearly 5 percent to 17,140. But then the major indexes recovered. Even after the drop Friday, the Dow closed at 18,085—nearly 1,000 points higher than it was in the days following Brexit. By Monday afternoon, after Brainard indicated she would look for “signs of further progress” before recommending a change in course, the stock market had made strong gains, though analysts expect it to remain choppy through the week.
“With markets at all-time highs, it takes very little to send the markets into a frenzy,” says Francis. “Our advice to clients is to stay put.”
This story was updated on Monday, Sept. 12, to reflect new developments.