Phew: Extreme Interest Rate Hikes Might Finally Be Over

Phew: Extreme Interest Rate Hikes Might Finally Be Over
Stéphane Renevier, CFA

10 months ago3 mins

What happened at the last meeting?

The Federal Reserve (the Fed) raised rates by a quarter of a percentage point on Wednesday, hoisting them above 5% for the first time since 2007. But what’s arguably even more important is what the central bank said about the future: the Fed’s chair Powell described a “meaningful change” in attitude, swapping out previous firm wording about future hiking policy for a more measured approach.

Powell even expressed confidence that a recession, even a mild one, is unlikely – even though some fellow Fed members disagree. He’s optimistic that the labor market could settle without an unwanted surge in unemployment, and believes the financial system's sound despite the current strains.

What does this mean?

That’s nothing unexpected, but still a biggie: this latest meeting indicates that the most aggressive rate-hiking cycle in history – which saw interest rates rise five percentage points – might have drawn to an end. The door’s still open for more hikes if we need them, of course, but a pause in June is now almost guaranteed. That’s understandable. The banking sector’s in turmoil, leading indicators are pointing toward a collapse in economic growth and inflation, and the labor market is finally showing signs of weakness. Under those conditions, it makes sense to wait and see how those hefty hikes impact the economy over the coming weeks. And while the Fed is currently pushing back against the idea of rate cuts, the graph above shows that investors are now expecting at least three of them before the end of the year, expecting rates to fall by almost a full percentage point. So going forward, expect more focus on rate cuts than hikes, and growth and financial stability rather than inflation.

Why should I care?

Now, it does seem that the economy and financial system have been more resilient than expected in the face of those aggressive rate hikes. Still, though, be careful following Powell's rather extreme confidence: hikes have only started to bite the economy, and past optimism from the Fed hasn't always translated into reality – we’re looking at you, 2008.

Investors may well cheer on a rate pause or cut, excited by the prospect of pumped-up asset prices that come as a result of lower rates. But the context is crucial here: if we do see the aggressive rate cuts that markets are pricing in for the next few months, that’s probably because a flailing macroenvironment will demand it. And while that should be positive for treasury bonds, it’s less so for stocks as firms risk seeing their profit shrink more than they expect.

So sure, a soft landing – where inflation returns closer to its 2% target without the economy plunging into a recession – is still within the realm of possibility. But there’s a reason that’s a rare win: the Fed's exceedingly blunt instruments make for long lags between rate hikes and their impact on various sectors, and the intricate interplay of numerous factors makes achieving the perfect degree of slowdown a Herculean task. And when the economy starts to really slow down, investors – aware of the risks of a harder-than-expected landing – will wait for cheaper prices before they shop for stocks. To me, it’s not the time to be reckless. Diversification can be the most important tool in uncertain times like these, so consider spreading your portfolio across different assets, sectors, and geographies – a little cash never hurt anyone, either.



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