At least one interest rate cut is still on the table for 2024, but in the short term, higher US borrowing costs are here to stay.
The Federal Reserve on Wednesday held rates steady for the seventh consecutive time and penciled in just one cut this year, down from the three it first projected last December.
Recent economic data has encouraged investors that inflation is cooling again after showing signs of sticking earlier this year. The Consumer and Producer Price Index reports for May both came in softer than expected this week, helping lead stocks to record highs.
Still, traders are widely expecting the central bank to keep rates where they are again in July. If the Fed does indeed hold off on changes, interest rates will stay at their current 23-year high until at least September.
How should traders invest in a higher-for-longer rate environment? Before the Bell spoke with Wylie Tollette, chief investment officer at Franklin Templeton Investment Solutions.
This interview has been edited for length and clarity.
Before the Bell: What do higher-for-longer rates mean for the stock market?
The stock market is always forward-looking, and I think the market may have already priced in the fewer rate cuts [before the Fed meeting]. As we've seen throughout the year, the expectation for rate cuts has been steadily declining.
What I find interesting and actually kind of invigorating is the resilience of the US economy in the face of these expected higher-for-longer rates. I think that we expected, consistent with most financial economists and investors, higher rates to really begin biting the economy more quickly and more significantly last year.
As it turns out, I think our new hypothesis, based on everything we've seen, is that these higher-for-longer rates are really just a return to a more normal rate environment, sort of a pre-global financial crisis rate environment.
Which stocks could perform poorly due to higher-for-longer rates?
There will be some sectors that higher-for-longer rates will impact. And we've already seen some of them. For example, real estate. Most real estate is financed. Commercial real estate in particular, offices and retail, I think will continue to suffer. We've seen that already, and I think there's probably still some more pain to come.
Another area like cars, the big purchases that many consumers finance. Obviously, higher-for-longer rates makes that financing more expensive. And so we can see consumer durables slowing down or suffering a little bit in this higher-for-longer rate environment.
In general, smaller-cap stocks, most regardless of sector, will probably have a harder time in this environment right now.
What about stocks that could perform well in a higher-rate environment?
Semiconductors, those we think will continue to do well. They've almost become the new defensives because they have so much cash on their balance sheet. They don't rely on financing to finance their internal growth and investment, and their demand cycles aren't terribly sensitive to higher interest rates. And we've seen that already priced into a lot of Big Tech. The Magnificent Seven, we actually continue to see pretty strong growth prospects for those companies in the face of higher rates.
Energy and materials traditionally do reasonably well in higher-for-longer rates.
We've seen utilities rally. We actually think that could continue. There's just a lot of demand for electricity with electric vehicles and artificial intelligence. We see utilities needing to increase supply and really being under pressure to do that, which provides an interesting and perhaps a rare opportunity to actually benefit and see some real growth in the utility sector.
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