Rate Hikes...Are We There Yet?
July 31, 2023
By Krista Eberly, CFP®, CIMA®
Investment Management Officer
All eyes were on the Federal Reserve last week as it met for its Federal Open Market Committee (FOMC) meeting. After its “hawkish pause” in June, the Fed raised interest rates by 0.25%. This was a unanimous decision from policy members and expected by the markets. What isn’t certain is what comes next for monetary policy.
With the Fed raising the federal funds rates, the rate banks charge each other for overnight loans, it put the new range at 5.25-5.50%. This is its highest level in twenty-two years and puts monetary policy into restrictive territory. According to the Fed’s June rate projections, policy members see one more 0.25% rate increase between now and the end of the year. The markets believe the Fed is done with rate increases. What they do agree on is no rate cuts in 2023.
In his press conference, Federal Reserve Chairman Jerome Powell did leave the door open for additional rate increases. The point he reiterated is the Fed will remain data-dependent and look at the totality of the incoming data when deciding if another rate increase is warranted. Also, he noted there are two months until the next policy meeting. That will give the Fed two months of inflation and labor market data to assess. A lot can happen between now and then.
Can the Fed Engineer a Soft Landing?
A ‘soft landing’ is the ability of the Fed to raise interest rates to a level that slows down growth to bring inflation to its 2% target without pushing the U.S. economy into a recession. Think of it like a pilot landing an airplane. We are over a year into the fastest tightening cycle in modern history and the U.S. economy has shown resiliency. The initial release of second quarter gross domestic product (GDP) last week showed that the U.S. economy grew at a 2.4% annualized pace. This is not only above economists’ expectations but also above the first quarter annualized growth rate of 2.0%.
While the U.S. economy has fared well thus far, we are not out of the woods yet. A recession is still a possibility over the next year. Why? Monetary policy works with ‘long and variable lags.’ The interest rate sensitive areas of the economy, i.e. housing, are the first to be impacted by rate changes. However, broader demand takes more time. Therefore, as Powell mentioned in his press conference, the full extent of tightening has yet to be felt. The strong labor market is a perfect example of this. The current unemployment rate is at the same level as when the Fed started tightening in March 2022.
Where Do We Go From Here?
While additional rate increases are possible, what we do know is the Fed is nearing the end of its tightening cycle. Inflation continues to move in the right direction but it will take time to bring inflation back down to its 2% objective. Powell doesn’t see inflation at that level until 2025. As a result, interest rates will remain higher for longer.
The positive for investors is that interest rates remain attractive across the maturity spectrum. High quality bonds are at their highest yields in a decade. In addition, they offer downside protection to your portfolio if the U.S. economy does enter into a recession at some point in the future and equity prices suffer. Bonds will return to their traditional role of helping dampen total portfolio volatility.
If you would like to discuss the Fed’s recent rate change in more detail and how that might impact you, please reach out to your SNB Wealth Advisor today with any questions or concerns about the current market environment. Your financial success matters to us!