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Last week, the US Fed raised interest rates by half a percentage point to a range of 0.75% to 1%. With US inflation at 8.5% in March 2022, the highest since 1981, further hikes are expected.

Naturally, the markets are spooked.

Mixed earning results by some of the large companies, the war in Ukraine, and Covid-related lockdowns in China have also kept the markets on edge.

This March, the US Fed raised its interest rates for the first time since 2018, and it signalled that it would raise rates again in May. The rate hike ended up being 50 basis points, and the commentary by Fed Chairman Jerome Powell suggested that similar hikes were ‘on the table’ in the future.

However, the Chairman ruled out a larger 75 bps rate hike going ahead. Since that had been the investors’ biggest fear, the markets cheered and were up by almost 1,000 points the day the rate hike was announced.

However, the belief is the Fed has been late in raising interest rates. Also, since the financial crisis of 2008, the US central bank has been injecting a lot of money into the system. When the pandemic struck, this process became even more accelerated.

There is excess liquidity in the system now, which needs to be drained out.

In the coming months, the Fed is also planning to reduce its bloated $9 trillion balance sheet. Even as Fed chair Powell explicitly ruled out a hike of 75 basis points in the coming meeting, according to the CME Fed Watch Tool, the expectation is that the Fed will raise its target policy rate by 0.75% in the June meeting, something that last happened in 1994.

Hence, the markets went into turmoil again. Investors are worried whether the Fed will be able to strike the delicate balance between slowing the economy just enough to keep inflation in check and yet not cause a downturn.

Any investor in the US markets will have one question – how will the Fed rate hike affect my portfolio?

The general logic goes like this — the overall health of the company is reflected in the price of the share. With the Fed hiking rates, borrowing would become more expensive.

Additionally, in a high inflation scenario, a company is likely to incur higher costs to pay its employees and in other expenses. Rising expenses would affect profit margins, which could lead to a decrease in the stock price.

However, the connection is not always this straightforward. One way to look at it is that this rate hike was already anticipated and has been factored into the markets.

So, we may not see any further significant effects on the markets. What matters here is not how this Fed rate hike will affect the markets. Rather how the markets will behave and how your portfolio will be impacted depends on what the Fed is expected to do going ahead.

Even if we do not see a 75 bps hike in June, we can’t say that the Fed is done with hiking rates. Two things will decide what can be expected going forward – how aggressive the Federal Open Market Committee is when it comes to hiking rates going ahead and whether the rate hike achieves the purpose of taming inflation and how quickly.

With rising gas prices and supply chain disruptions, inflation is likely to remain high in the short term, and Fed is expected to take proactive measures to tackle that.

In the last few years, most of the growth has been coming from investments in growth stocks where investors would bet on a company being successful in the future even though it was not making any money in the present.

This is likely to change going forward. Also, the 10-year treasury yield has risen to its highest since November 2018 and stands at over 3%.

This means that investors will find it easier to earn higher interest on bonds and focus on low-risk income opportunities instead of investing in high-risk stocks.

One must understand that while inflation will always tend to push asset prices higher, this period of high inflation is cyclical.

Your portfolio may continue to grow if it is not concentrated in a few high-risk stocks and is suitably diversified.

While one can expect market volatility to continue, investors would do well to invest with a long-term horizon and by not making any knee-jerk reactions to the current situation.

(The author is Co-founder & CEO, Vested Finance)

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