The Nasdaq Composite Index (NASDAQ: .IXIC) has drifted lower this week and was volatile in Thursday's US session. It closed trading more than 65 basis points in the red.
Meanwhile, the BetaShares NASDAQ 100 ETF (ASX: NDQ), which tracks the index here on the ASX, edged up 1% in yesterday's session. It recently hit all-time highs.
Fanning the flames this week has been the latest US economic outlook from the US Federal Reserve Chair Jerome Powell.
Powell's remarks in his speech to the World Affairs Council on the outlook of the world's largest economy covered inflation, interest rates, and the labour market.
Interest rates on US Government debt spiked to highs of 4.45%, up from 4.39% a day earlier. Could this move have sparked yesterday's volatility in the Nasdaq Index? Let's see.
Nasdaq Index drifts lower
One key reason for the Nasdaq Index's shaky performance is the ongoing uncertainty surrounding US interest rates.
Fed Chair Jerome Powell signalled that the Fed will be cautious about lowering rates, even as inflation gradually moves closer to its target.
This "wait-and-see" approach may have sparked concerns, particularly as tech and growth stocks dominate the index and are highly susceptible to interest rate changes.
Higher rates can dampen the appeal of growth stocks by increasing borrowing costs and reducing future cash flow valuations.
But higher rates are also necessary to crack the back of inflation, something Powell says we are close to hitting, but not quite there.
Inflation is running much closer to our 2% longer-run goal, but it is not there yet. We are committed to finishing the job. With labor market conditions in rough balance and inflation expectations well anchored, I expect inflation to continue to come down toward our 2% objective, albeit on a sometimes bumpy path.
Consequently, the Fed isn't in any rush to lower rates, as it has done in the past – like during the 1970s. Back then, inflation soared to double-digits, resulting in double-digit interest rates on loans and mortgages. The effects were deeply felt.
According to Powell:
We know that reducing policy restraint too quickly could hinder progress on inflation. At the same time, reducing policy restraint too slowly could unduly weaken economic activity and employment…
…The economy is not sending any signals that we need to be in a hurry to lower rates. The strength we are currently seeing in the economy gives us the ability to approach our decisions carefully. Ultimately, the path of the policy rate will depend on how the incoming data and the economic outlook evolve.
This could have added pressure on technology-heavy indexes like the Nasdaq Index.
What does this mean for investors?
For Australian investors holding stocks in the Nasdaq Index, the interest rate situation is crucial to consider.
Interest rates are about the only tool central banks have in the fight against excessive inflation. So-called "sticky" inflation, which is stubborn to the Fed's moves, could signal a 'higher for longer' scenario.
That means interest rates wouldn't necessarily expand but wouldn't contract either until inflation is tamed.
As a result, fluctuations in US monetary policy directly influence the value of stocks in the index, and yesterday's comments from the Fed Chair may have stirred yesterday's volatility.
Nasdaq Index takeout
Despite the short-term pressures, the long-term outlook for the Nasdaq Index and the US economy remains fairly strong.
While short-term interest rate fluctuations can affect the basket, corporate fundamentals and the broader economy drive values higher or lower in the long term.
