Interest rates: Why the Fed may be the next problem for investors

State Street Global Advisors Chief Investment Strategist Michael Arone and eToro USA Investment Analyst Callie Cox discusses the possibility that the Fed is once again prepared to raise interest rates and what that could mean for investors.

Video transcript

- Debt ceiling drama may soon be behind us, but the good times keep rolling. Now, onto the market's next hurdle-- pros are saying that it's a true toss up if the Federal Reserve will hike rates again at its June 14 meeting, suggesting there could be more market movement ahead. The market currently sees around a 60% chance of another hike, but sentiment has fluctuated in recent weeks.

The US jobs report out Friday could tip the scales. Joining us now to discuss, we have Michael Arone, State Street Global Advisors' Chief Investment Strategist, and Callie Cox, eToro USA Investment Analyst joins us now as well for this conversation. Michael and Callie, thanks for taking the time this morning.

Callie, I'll go to you first. Even as you think about what this next potential fed decision could hold for the markets and the volatility that could ensue, is it any different from volatility that we've already seen leading up to this point in the Year

CALLIE COX: Well, you know lately we haven't seen much volatility. So I think that's the funny part that everybody's trying to contend with, but no I think as we approach the fed meeting, a lot of the catalysts look to be the same. I mean, inflation is still not under control, even though it's progressing in a nice direction, It's definitely progressing lower.

The job market by all indications still seems to be strong, and that really is the equation for the fed right now. The fed is trying to balance inflation by hammering the job market, and by that equation, another hike may be on the way.

- And what's really interesting to me about that Michael is as somebody was pointing out on Twitter this morning, like, the markets and the fed just can't get on the same page, can they? Because the market still seems to be pricing in a cut before year end, even though the fed has indicated pretty strongly that's not its base case at all.

And the fed commentary we've gotten recently is not clear that there's going to be a raise at the June meeting, yet the market thinks there's going to be a raise. Like, what are the risks when they are not on the same page in that fashion?

MICHAEL ARONE: So I think the risk is certainly disappointment. So what's really interesting about this, Julie, is that it's kind of ironic that if the fed were to cut rates, typically, the markets react negatively when they're cutting rates because they're cutting for a reason. We're either already in recession. So if you thought they were behind on inflation, they'll probably be-- we'll already be in recession when they start cutting rates, or there'll be something wrong in the capital markets. So that's not great for risk assets going forward.

On the flip side, if they were going to kind of tighten rates, the market's not on the same page, and they're not expecting that. So I don't think that that's particularly good for risk assets either. So I think what's really interesting is this purgatory, this limbo period-- it's probably best in terms of from the last rate hike to the first rate cut.

Risk assets can do OK, and that might be the environment we're currently in as the market seems to teeter around 3,800 or 4,200. We've finally broken through that level on the S&P 500, but it's taken a while. And so I think that this limbo period might be best for markets because if they cut or tighten, I think, both those scenarios could be a problem going forward.

- Perhaps just for the sake of this conversation too in contextualizing what indicators people should remember to pay attention to and look for as the fed is going to eventually pivot at some point, but the specific indicators that they're going to look at to actually determine whether or not they need to pivot.

MICHAEL ARONE: So Brad, I think everyone must have been on vacation on Friday, or they were distracted by the debt ceiling because I can't believe the market's reaction to the PCE-- the core PCE. It showed an acceleration of inflation, and the market didn't blink, and that was a bit surprising and a departure from what we had observed earlier in terms of some of the reactions to higher than expected inflation.

So I think inflation is going to continue to be a key. Does it continue to come down towards the fed's target? We know it won't get there this year, but directionally it needs to be headed that way. And then certainly, this is a big week for the labor market, ADP, the jobs report. And I think the fed continues to be equally confused by the fact that the labor market hasn't softened yet after all those rate hikes. And so I think that seeing some weakening, some softness there would be key to at least the fed pivoting or stopping their rate hikes.

- The market didn't blink on Friday in part because it was too taken aback by NVIDIA perhaps, and I don't want to cannibalize our later conversation because we're going to talk about NVIDIA. But what I'm struck by once again this morning is the strength in-- Callie, I'll take this one to you-- the strength in the NASDAQ futures, right?

In the face of-- if the debt ceiling thing is indeed resolved, you would think yields could be potentially moving higher. That wouldn't be good for tech, although yields aren't moving higher this morning. But like, how are you thinking about how all of this and as it relates to big tech?

CALLIE COX: Yeah. So I think the way that tech has moved lately has really shown us that there are a lot of different flavors when it comes to technology. Obviously, there's a lot of hype around AI. I think some of the hype is warranted, and of course, we'll get into that in a few minutes, probably, but I think that investors are looking at tech in two very different ways. A, for its potential for future innovation, and that's where AI comes in.

But on the other hand, I think a lot of investors are looking at big tech towards safety because everybody thinks of big tech as these high-flying growth companies, but they're really not that anymore. They're some of the companies on the stock market that have the strongest profit margins, the strongest cash hoards, the most durable balance sheets, and I think investors are taking in stride as both.

I am a little worried because as you mentioned, yields are moving higher, and the NASDAQ doesn't seem to be blinking. That seemed a little out of step for me. But at the same time, I can understand why investors are looking at tech the way that they are. And I can also understand why it could seem really confusing because it's a sector that's in transition at the moment.

- And so Callie, even as you were talking about the multiple flavors of tech, I wonder if there is a specific flavor within AI that is the most tasty for investors to perhaps kind of ponder at this point in time?

CALLIE COX: I think it's really too early to know which flavor could excel with an AI because of course, AI is a longer term story. I think everybody can agree on that. And it's in its very early stages. I mean, if you're thinking about how to invest in a longer-term same theme, I think you have to almost look at a basket of stocks because it is too early to tell who could be the market leader here.

And it could very well be big tech. I mean, Google and Microsoft, of course, are pretty high up in the chase for AI at the moment, but at the same time, they have a lot of disruptors nipping at their heels.

So right now, I think it's a really, really tough to put all your eggs in one basket when it comes to one stock leading the AI race. Because if it is a long-term story, these leaders are going to change. And you may be in the camp where you might just want to put a little money in each one, instead of betting on one to win it all.