The Federal Reserve was the source of much intrigue this week, as members were at odds over the path forward for interest rates.
At a headline level, the Federal Open Market Committee surprised no-one when it held its benchmark interest rate at between 3.5% and 3.7%, but inclusion of language in its statement – which suggested interest rates could be cut in the coming months – was met with opposition.
The decision prompted the most dissenting votes (four) within the Federal Open Market Committee since 1992, as three members dissented in favour of dropping the reference, while Stephen Miran, who is a US President Donald Trump appointee to the committee, dissented in favour of cutting rates immediately – a positioned he has maintained since joining the board last year.
Despite the dovish tone of the statement, the front end of the US interest rate yield curve rose, suggesting that markets expected interest rates would increase.
It marks a clear turnaround from where sentiment was at the beginning of the year, as markets had hoped for continued cuts to interest rates in 2026.
Harbour Asset Management portfolio manager Shane Solly told NBR it shows the market is worried about prices rising. “This changing inflationary environment off the back of the Iran situation, it’s creating short-term pressure.”
He said it was quite right for several members to object to cutting rates, given the buoyancy of the US economy. “I think that’s actually good banking practice … I think it does put a bit of trust back into the Fed.”
Harbour Asset Management’s Shane Solly.
This week’s meeting was the last to be chaired by Jerome Powell, after Trump’s replacement, Kevin Warsh, cleared a key hurdle on his path to taking over the role.
Before his nomination, Warsh was of the view that interest rates should be lowered – a stance Trump has long advocated for.
With signs of dissent amid the FOMC about cutting rates, and market pricing taking a different view to the Fed’s messaging, there will be much interest in how Warsh comports himself in the role and leads the world’s most important central bank.
The Fed wasn’t alone in leaving its benchmark interest rate unchanged this week, with the Bank of England and the European Central Bank taking a similar approach. Both central banks said they were worried about the prospect or rising domestic inflation.
US earnings
Despite the disruption the war in Iran is wreaking on commodity markets and supply chains, equity markets have surged, with the the S&P 500 notching its biggest monthly gain since November 2020.
The surge has been driven in part by investors’ belief that the conflict will be short-lived and the Strait of Hormuz will soon reopen, as well as strong first-quarter earnings by some of the tech titans that make up the Magnificent 7.
Front of mind for investors heading into this reporting period was whether the likes of Alphabet, Meta Platforms, and Microsoft could deliver earnings that justify the huge investments they have announced in artificial intelligence.
“As a group, they met or beat expectations,” Solly said, adding that some did better than others.
Alphabet, the parent company of Google, was a standout, as it exceeded revenue expectations on the back of its surging cloud business.
However, Facebook’s owner Meta Platforms disappointed due to weaker user numbers and capital expenditure that was below market estimates.
Solly said massive amounts of capital being invested into artificial intelligence are driving the US market up, with analysts now expecting a combined spend of US$700 billion, which is about 2% of US GDP.
He said the market was still wary about whether the returns on offer in the sector will ever justify the huge sums invested.
“Maybe it looks a bit more like the capital-intensive airline industry, than a … sort of winner-takes-all network effect, like we’ve seen in the internet economy.”
Members of the ‘Magnificent Seven’.
A canary in the coalmine?
Local investors also had plenty to digest this week, with SkyCity warning on Friday that it expects its profits will be lower than expected this year, as customer patronage has been hit by higher fuel prices.
It is now expecting reported earnings before interest, tax, depreciation, and amortisation of $155 million to $165m for the year to June, down from previous guidance of $170.6 to $190.6m.
The company said trading and visitation had been affected at its Auckland and Adelaide precincts since March, particularly by fuel price rises.
The revised guidance was based on current trading conditions persisting for the rest of the financial year, it said, but “significant uncertainty exists on the breadth and duration of prevailing macroeconomic conditions, and further deterioration in these conditions could affect this guidance”.
Solly said the downgrade was “unfortunate” because the business was just starting to come out the other side of challenging economic conditions that had plagued cyclical stocks in recent years, only to be hit by higher fuel prices and waning consumer sentiment.
The question for investors now is whether other publicly listed firms will be forced to report downgrades of their own.
