"Long-term high interest replaces rate hikes"! On the eve of the Federal Reserve's decision, the market embraces the "new logic of the central bank," have the rules of the game changed?

On the eve of the Federal Reserve's interest rate decision, the market has truly begun to accept the notion that "higher rates will be maintained for a longer period of time."

The overnight US Treasury yield continues its recent upward trend, with the 10-year Treasury yield reaching its highest level since 2007, and the 2-year yield approaching its highest level in over a decade.

The US dollar index, which measures the value of the dollar against six major currencies, briefly fell below the key level of 105 but ultimately closed up 0.07%. This marks the index's ninth consecutive week of gains, the longest upward trend in nearly a decade.

In terms of the extremely short end of the yield curve, expectations for interest rate changes for the remainder of the year have moderated. At the same time, expectations for interest rate changes next year have also declined. The market is pricing in more stability in interest rates rather than rate cuts.

Furthermore, according to the FedWatch tool by the Chicago Mercantile Exchange, the probability of the Federal Reserve keeping rates unchanged at the remaining three monetary policy meetings this year has risen to 99.0%, 70.8%, and 59.8% respectively. Investors also anticipate only a 50.1% chance of a rate cut by the Fed in June next year, down from over 80% a month ago.

Evidence of "Longer Period of Higher Rates"

Some analysts have seen clues from last week's inflation data that the Federal Reserve will maintain higher rates for a longer period of time.

Due to a significant rebound in oil prices, the overall Consumer Price Index (CPI) in the United States increased by 3.7% year-on-year in August, marking the second consecutive month of rebound and the largest monthly increase in 14 months.

Excluding the more volatile energy and food categories, the core CPI in August rose by 0.3%, the first acceleration in six months, and higher than the economists' forecast of 0.2%.

In response to this, Julie Biel, Portfolio Manager and Senior Research Analyst at investment management firm Kayne Anderson Rudnick, stated:

This supports the view that rates will remain at higher levels for a longer period of time because inflation is still relatively high in certain areas.

In addition, a series of recent US economic data has shown resilience, delaying the market's expected date for rate cuts. For example, the US ISM non-manufacturing index in August exceeded expectations, reaching a higher-than-expected 54.5, a six-month high. In addition, non-farm employment in the US increased by 187,000, surpassing expectations.

Karl Schamotta, Chief Market Strategist at Corpay, previously stated, "The US economy continues to challenge widespread skepticism, and the persistent upside surprises are driving yields higher."

It is worth mentioning that the ongoing labor strike movement in the United States has ignited concerns in the market about economic recession and upward inflation.

Ian Shepherdson, Chief Economist at Pantheon Macroeconomics, predicts that if the UAW members of the "Big Three" in Detroit launch a comprehensive strike, the US quarterly GDP could be hit by 1.7 percentage points.

Michael Hartnett, a Bank of America analyst, believes that the 2020s will be an era of inflation and rising interest rates, with labor strikes being one of the three major reasons. Labor unions have become a core driving force behind inflation. The high US deficit and geopolitical factors will also exert upward pressure on interest rates and inflation.

However, US Treasury Secretary Janet Yellen stated that the overall US economy does not show signs of an imminent recession and is still in a "healthy" state. Industrial output is rising while inflation is declining.

Yellen also said that it is too early to judge the impact of the major automotive industry strike on the economy, as it largely depends on the duration of the strike and who is affected.

In addition, although Federal Reserve Chairman Jerome Powell made a strong statement at the Jackson Hole Global Central Bank Annual Symposium, he did not say anything surprising. The Federal Reserve will continue to rely on data as it waits for inflation to fall back to 2%.

"Longer-term higher interest rates" cannot simply replace rate hikes.

The answer is not black or white.

In theory, central banks can provide some degree of constraint by setting interest rates at an extremely restrictive level for a short period of time or at a moderately restrictive level for a longer period of time. Maintaining a more stable interest rate path, rather than sharply raising and lowering rates, is preferable because it allows decision-makers more time to assess economic data.

However, reality is often influenced by more complex factors, such as damage to central bank credibility and greater stickiness of inflation. Therefore, tomorrow's commitment to restraint and no longer maintaining high interest rates in the long term cannot completely replace today's actions. Analysis predicts that the Federal Reserve will pause rate hikes in September and continue to present alternative options with a firm and resolute tone, creating room for a gradual transition to rate hikes suspension. The central bank will only consider the option of raising rates again when inflation and labor market rebalance, and economic growth exceeds expectations.

Are Tech Stocks About to Fall from Grace Again?

Keeping interest rates high in the long term may provide support for the US dollar, but it's not good news for tech stocks, especially those with high valuations.

According to FactSet data, as of last week, the information technology sector had a price-to-earnings ratio of 25.5 times the expected earnings for the next 12 months, higher than the 20 times at the end of last year and the 10-year average of 18.5.

Among them, the expected price-to-earnings ratio for this year's biggest winner in the tech sector, NVIDIA, is 31.7 times. In addition, Microsoft and Apple have expected price-to-earnings ratios of 29.9 times and 26.9 times, respectively.

Large-cap tech stocks in the non-essential consumer goods industry appear to be even more expensive. Amazon has a price-to-earnings ratio of 50.1 times, and Tesla has a price-to-earnings ratio of 63.8 times.

It's worth noting that investor enthusiasm for tech stocks has been driven not only by innovation in software and hardware companies but also by ultra-low interest rates, which have made the future profits promised by these companies particularly valuable. Therefore, investors are willing to pay higher prices in exchange for future returns.

Last year, when the Federal Reserve began raising rates significantly to curb inflation, the game changed. By the end of 2022, the technology sector of the S&P 500 index had fallen by 29%, becoming cheaper relative to earnings and falling below the S&P 500 index for the first time since 2013.

In response to this, John Davi, CEO and CIO of Astoria Portfolio Advisors, said:

For a world with higher real interest rates and higher inflation, there is a new script, and something that has worked for the past 10 years does not necessarily mean it will work in the coming years.