Yesterday, the stock market saw its’ worst day since February this year. Dow Jones fell 3.15%, S&P 500 3.29%, and Nasdaq was down by over 4%. Technology stocks led the drop.
As I write this, the European markets are also facing a sell-off.
The main reason the stocks fell was the news of an interest rate hike by the Federal Reserve. When asked about the fall in stock prices, the President with the ‘best words’ said that the Fed had gone crazy.
Why is the Fed raising interest rates?
As the global economy strengthens, the employment numbers are rising. The unemployment rate in the United State just hit a 49 year low. With the economy near full employment, businesses cannot just replace their workers so they offer them incentives such as higher pay to stay. High employment also puts the workers in a good position to demand higher wages.
The recent economic reports show that wages are finally rising after declining or remaining stagnant for decades. If people start to earn more, they tend to spend more. This increase in spending pushes the prices of goods and services higher thus raising inflation.
To subdue the inflation rate, the Federal Reserve raises the interest rate, which keeps the prices of goods and services in check. The Fed hasn’t had to increase the interest rate in the past decades because the wages for most people mainly remained stagnant while the rich got richer.
Why do the rate hikes by the Fed affect the stock market?
When the interest rates are low, investors tend to prefer equities since they offer a better return albeit with inherent risk. But when the Fed raises interest rates, it makes treasuries a worthwhile option for investment. So the investors get their money out of equity markets and buy treasuries.
This sell-off pulls down the stock price so as a general principle, higher ROIs on treasuries discourage investment in the equity markets. This was why the stocks were down yesterday and fears of a bearish trend loom over the European markets.
What this system means for a society as a whole…
If it were up to the hedge fund managers and the class they serve, everyone would live with a perpetual fear of losing their job. Job security, like free education and healthcare, would be a utopian idea, too idealistic to discuss in the spectrum of the acceptable opinion.
If workers feared that they might lose their job next month or next week, they would be less likely to ask for job benefits and better pay. It means they would have less money to spend, posing no risk to the inflation rate. Thus, there would be no rate hikes from the Fed and the stock market would keep rising.
As dystopian as that sounds, it is what had been happening prior to the Trump Presidency. Wages didn’t rise for most people while 99% of all new wealth went to the top 1%.
President Obama, under the guise of a populist, made the wealthy wealthier while median household incomes went down. The stock market did triple during his terms but 10% of American families own 81% of the stocks so they were recipients of most of the profits. Obamacare too benefited the insurance companies, sending their stock prices through the roof.
I am not praising Trump. The tax bill he passed overwhelmingly favors the rich while it throws only crumbs to the class that needs help the most. But Trump is a narcissist. He doesn’t do the right thing for the sake of doing right but to bolster his own status and image.
With the elites in both parties against him, he knows he needs to win the people over. This was what Bill Clinton did when he moved away from Republicans and Democrats during his Presidency.
Trump’s plan to lift the federal ban on the use of ethanol blends of gasoline during summer was to win favor from the farmers ahead of the midterms. It hurts the fossil fuel industry but helps the little guy. Trump’s reasons may be political but they do have populist reverberations.
Note: This article or anything else on this website does not constitute an investment advice. Talk to your financial advisor and invest at your own risk.