These 2 stocks are rooting for a Fed rate hike
Investors have been watching the Federal Reserve like a hawk recently, and they’ve been waiting for this day for a long time. The central bank has telegraphed its intention to start raising interest rates, and with a decision expected this afternoon, only a surprise U-turn prompted by Russia’s invasion of Ukraine would prevent the Fed from raising its principal. short-term interest rate of at least a quarter of a percentage point. Rate hikes often prove difficult for equities, but market participants just seem to want some clarity going forward. Starting at 11:30 a.m. ET, the Dow Jones Industrial Average (^ DJI 0.86% ) was up 385 points to 33,929. S&P500 ( ^GSPC 1.30% ) rose 70 points to 4,333, while Nasdaq Compound ( ^IXIC 2.14% ) jumped 357 points to 13,306.
As you can see from the rise in the Nasdaq, dejected tech stocks have seen a nice rebound from recent losses. However, a few stocks that go largely unnoticed also posted strong gains. Below we will take a closer look Charles Schwab (SCHW 5.87% ) and Interactive brokers (IBKR 4.96% ) to reveal why they’re doing better and why a rising rate environment might actually be good for brokerages.
A big day for brokers
Shares of Schwab and Interactive Brokers rose at nearly the same pace, rising between 5% and 6% on the day. Several factors have combined to make investors more optimistic about the two brokerage firms and their respective future prospects.
The most obvious boost for Schwab and Interactive Brokers came from renewed investor confidence in the stock market. Although trading commission revenue has declined in light of decisions by Schwab and other brokerage giants to charge no commission on many stock trades, brokerage firms are still benefiting from greater volume. The more investors take interest in the stock market, the better these companies fare – and the threat of a long correction or bear market has weighed on sentiment recently.
However, there is also a more direct connection between the fortunes of Schwab and Interactive Brokers and what the Federal Reserve might do later today. When investors open brokerage accounts, they often leave large sums of money uninvested. Brokers can use this uninvested capital to make money, typically paying little or no interest on cash balances in brokerage accounts. When the Fed raises the federal funds rate, the amount brokers can earn on that money typically increases more than they pay their clients.
In Schwab’s case, moreover, money market mutual funds also play a key role. Schwab offers these investments as a way for investors to hold money in a cash-like instrument with full liquidity and minimal risk. However, Schwab had to invest that money in securities that paid very little interest, and as a result the funds had to forego some of their expenses just to earn their earnings to earn shareholders positive income.
If interest rates rise, money market mutual funds will be able to earn more income from their investments. Some of this money could go to investors, but the most immediate positive impact will be that Schwab and its peers no longer have to offer these costly subsidies to their customers.
Keep your eyes on the Fed
In addition to the amount of any rate hike, discussing the Fed’s rationale for its decision will be critically important. Investors want to have a better idea of what the future holds when it comes to monetary policy, so they can plan more effectively and adapt to changing economic conditions. For now, everyone seems hopeful that the central bank will once again manage to keep the economy in balance even in these tough times.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.