What's Next? | The Rate Hike Rundown
The central bank raised the federal-funds rate by 0.75% for an unprecedented third straight meeting this week, taking the funds rate target to 3.0% to 3.25%. At the same time, Fed officials indicated they expect continued rate increases that could take this key short-term rate to 4.6% next year. All this is being done to get inflation down from 40-year highs, and so the key question on everyone’s mind is what’s next and what can we expect.
Rates Will Keep Rising
The most obvious takeaway from the Fed meeting is that short-term interest rates will continue to rise, and they will keep rising until officials are comfortable with the idea that inflation has really subsided and is heading lower. Currently, the Fed’s projections suggest that the federal funds rate will rise by another percentage point by the end of the year, an exceptionally fast pace for rate increases by historic standards. The fact that the economy and the job market has remained as healthy may compel the Fed to remain aggressive with rate hikes. In addition, the fact that rates have been lifted as much as they have means that when it comes time to lower them, there is plenty of room to bring them down.
Maybe a Hard Landing
In the bond market, short-term interest rates are now meaningfully above long-term interest rates, which is known as an inverted yield curve. In the real economy, data is accumulating that a slowdown is building. Richard Wiess, chief investment officer for multi-asset strategies at American Century Investments, notes that manufacturing surveys are almost uniformly pointing to a contraction, and now evidence is growing of a slowdown in the housing market.
The Earnings Outlook
The stock market has been supported by continued strong corporate earnings. In a matter of weeks, third-quarter corporate earnings will be coming out. However, they’ll largely reflect an economy with continued strong consumer spending and a strong job market, albeit with the continued pinch from inflation. That will likely mean an even greater-than-usual focus on what guidance companies will give for future earnings. An interesting fact is that inflation usually lifts corporate earnings in nominal terms and could offset some of the downward pressure from an economic slowdown.
Not a `V-Shaped’ Bounce
The adage of “this time it’s different” may ring true here. A quick bounce back in the markets is often referred to as a “V-shaped” recovery because of how it looks on a chart. During the pandemic-driven bear market, stock investors were in essence bailed out by the Fed’s extremely aggressive efforts to support the economy through the financial markets. This was accomplished by lowering rates. This time, the Fed is in a determined tightening mode. In addition, historically, the markets have benefited from what is called a “Fed Put”. This refers to the Fed coming in at the bottom of the market and effectively buying financial assets. This time, the likelihood of a Fed put is extremely slim.
All things considered, having a concise financial plan with a well allocated and diversified portfolio will allow investors to continue to navigate this storm.