Isranomics

Will the Fed’s attempt to fight inflation impact Israel?

by | Aug 31, 2022 | Stock Market | 0 comments

Last Friday was marked by a dramatic sell-off in the US following Jerome Powell’s eight minute speech. Around $2 trillion has been wiped off from the valuations of companies listed on the NYSE. The Fed’s chair reiterated that they are committed to tackling inflation via raising interest rates even though it will hurt the US economy in the interim.

What about Israel? Inflation in Israel is much lower than in the US and there are no talk of recession (at least for now). The composition of the companies on the Tel Aviv Stock Exchange is also different from that of Wall Street. However, the declines reached Israel on Sunday when the local exchange opened following the Fed chairman’s speech. As a consequence, the key indices in Tel Aviv lost between 1.2%-1.6% by the end of the day, with TASE further faltering on Tuesday and Wednesday.

Analysts believe that US stock market gains in June and July were a result of a positive trend of falling commodity prices, better than expected job numbers and decent corporate earnings numbers. As a result, investors believed that preceding months’ decline was overdone, and with the inflation showing signs of moderation, the expectation grew for a less aggressive increase in interest rates.

This is not surprising as Fed practised a policy of “accommodation”, keeping interest rates low for over a decade and stepped in every time when there was a need.

The eight minute speech highlighted the misbalance between what markets want the Fed to do versus what it was clearly saying it was going to do. Therefore, this message from Jerome Powell has eliminated all ambiguity for dovish interpretations. In fact, based on the speech, Powell is fully aware of the consequences of the Fed’s policy and the negative impact it will have on the households and the economy overall.

Some analysts believe that after the sharp falls on Friday, stock prices still remain elevated relative to the fundamental values of the companies. In addition, the outlook for those companies does not look promising either. The Fed has clearly outlined that its priority is to tame inflation and the strength of the economy is not the focus of its current policy. And this is where the problem lies—private consumption in the US accounts for 70% of GDP. Therefore, as long as inflation remains high, the consumer will be forced to spend less and as a consequence, the companies’ earnings will be hit in the near term. So, regardless of how one sees this situation, it does not look great for the stock market.

What’s more is that despite current headwinds, analysts’ earnings forecasts for companies almost did not change. For example, the average earnings per share in the S&P 500 companies in the next twelve months have increased by 11% (from $204.5 to $227). As the economy in the US has officially entered recession and the other countries in the world are facing similar prospects, this forecast remains unrealistic.

For the Israeli market, the prospect of recession is not imminent at the moment, partly because of the strong high-tech services. For the local exporters to start feeling a negative impact, it will require significant cuts in spending by the US based companies. Things will have to deteriorate meaningfully before it will be felt across the economy. At present, private consumption remains strong despite the interest rate increase. Though, should there be a rapid rise in the interest rate by the Bank of Israel in order to tackle the issue of inflation, this will certainly have a negative impact on the economy and the capital markets in the country.

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