The Fed Just Raised Interest Rates by Half a Percentage Point. How Could This Impact Your Clients?

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All eyes were on the U.S. Federal Reserve this week, as it wrapped up a crucial policy meeting in Washington, DC on Wednesday. For the first time in 22 years, the Fed raised interest rates by a half percentage point—part of a series of aggressive moves the Fed is making to assuage the economy.

Note: Rate is the federal funds rate until Sept. 27, 1982, the federal funds target rate until Dec. 15, 2008, thereafter it is the upper limit of the federal funds target rate range.  

Source: U.S. Federal Reserve via The New York Times, May 04, 2022.

The central bank also said it plans to whittle down its $9 trillion stockpile of Treasury bonds and mortgage-backed securities starting on June 1, 2022. Initially, the Fed plans to reduce its holdings by $47.5 billion a month. After three months, the Fed will ramp up to $95 billion a month in asset reductions, a move that could drain liquidity from money markets for years to come.

Earlier in March, the Fed hiked its benchmark borrowing rate for the first time since late 2008, upping it by a quarter-percentage-point. The moves are part of a double-barreled effort to slow the economy and ease price pressures that are at a four-decade high.

Since March, inflation has continued to surge, hitting a fresh 40-year high (yet again) last week. While the labor market has recovered since the outset of the pandemic, the Fed’s more common pace of rate increases still might not be enough to avoid a recession in the coming months.

The Fed reiterated that “inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.”

Economists — including some at the Fed — believe that America is nearing what some experts refer to as “maximum employment.” And, with the war in Ukraine still at full throttle, price pressure on things like food, home goods, and energy is unlikely to go away any time soon. Indeed, it is the confluence of these factors that have summoned the Fed’s increasingly hawkish tightening policies.

Many investors had already priced-in the rate hike—after Federal Reserve Chairman Jerome Powell said last month that a half-point hike “will be on the table”— so, the stock market was seemingly more at ease following Wednesday’s announcement. Certainly, the devil will be in the details and in the future guidance from the Fed’s policy-making committee, as well as its plans for its enormous balance sheet.

The Fed’s plan to reduce its holdings is likely to take some steam out of financial markets and could help to cool the housing market as it lifts longer-term borrowing costs, reinforcing the effect of the central bank’s interest rate increases. The Fed’s anticipated moves have already begun to push mortgage rates higher.

At the same time, the cost of living has jumped 8.5% in the past year, according to the Consumer Price Index. By comparison, inflation rose less than 1.4% a year on average in the decade preceding the pandemic.

Another big contributing factor to the tumult, analysts have noted, is the broad global shortage of supplies after the U.S. and other countries began to recover from the pandemic.

Businesses were unable to cope with the sudden flood of demand fueled by government stimulus payments because they could not obtain enough materials to produce all the goods and services that customers desired.

In any case, the Fed is now prepared to move quickly to raise rates to try to slow demand and reverse rising high tide of inflation. 

In the wake of the Fed’s announcement on Wednesday, U.S. stocks rallied across the board after Fed Chair Powell ruled out significantly larger rate hikes and emphasized the possibility of a soft landing—tamping down inflation while attempting to not induce a recession per se.

 

Key indexes and all 11 S&P 500 sectors were positive at the close of trading on Wednesday, as several noteworthy investment strategists noted that the Federal Reserve delivered on its guidance and eased investors’ concerns about the path of its rate hiking.

 

Author: Jay Manciocchi
Clout, Head of Content

 

 

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