7 months ago • 4 mins
The Federal Reserve (the Fed) might finally be ready to put the hiking boots aside and take in the view from inside instead. But even though the central bank might be chilling on interest rate hikes, we’re far from guaranteed a state of bliss.
✍️ Connecting The Dots
The Fed has been on a 14-month crusade to vanquish runaway inflation, and this week’s swing of the sword could potentially be the US central bank’s final one. As expected, the Fed raised interest rates by a quarter of a percentage point on Wednesday, marking its tenth consecutive increase in just over a year. That took the federal funds rate to a target range of 5% to 5.25% – the highest level since 2007, and up from nearly zero early last year. And the Fed’s chair Jerome Powell even hinted that Wednesday’s hike could be the central bank’s last – although he did stop short of declaring victory in the fight against high inflation, and left the door open for more rate increases in case they’re needed.
But while markets are now expecting rate cuts before the end of the year, Powell strongly pushed back against the idea. Instead, it sounds like the central bank will likely keep interest rates high to stub out inflation once and for all – even if the US economy struggles. And in case there was any doubt, data out a week ago confirmed that the world’s biggest economy is indeed struggling, slowing to grow at an annualized pace of just 1.1% last quarter – well below the previous quarter’s 2.6% and far short of the 2% that was expected. What’s more, the report doesn’t even capture the full extent of the damage done by the ongoing banking crisis, which only started to unfold in mid-March.
The turmoil claimed another victim this week: on Monday, First Republic became the third bank to collapse in the past two months, wiping out shareholders in the second-biggest bank failure in American history. Needless to say, that’s not good news, and even Powell warned on Wednesday that the recent stress in the financial sector will result in reduced bank lending and diminished economic activity. Credit, after all, is the lifeblood of the economy: when it gets harder to borrow cash, consumers spend less and businesses don’t invest as much, derailing economic growth and increasing the odds of a recession.
1. For soft landings, they’re pretty darn hard.
Powell said that he still believes the US economy will achieve a so-called “soft landing” – that dream scenario where the economy slows enough to tamp down inflation, but stays strong enough to avoid a recession. But if history’s anything to go by, the chances of the Fed successfully engineering a soft landing are low. See, apart from one rate-hiking cycle in the 1980s, every other round of interest rate hikes has been less aggressive than this current one – and still, most of them were followed by a recession at some point.
2. You might want to keep your cup half empty for now.
Markets are arguably underestimating the risk of a hard landing, so it might be worth exercising caution with your investment portfolio. To do so, you could reduce your risk exposure and make sure your portfolio is well-diversified and doesn’t contain leverage. Consider holding less in stocks, and where you are holding them, consider tilting toward defensive sectors. It may also be worth adding some long-term government bonds – possibly the best hedge against a recession – and gold to your portfolio. Remember, during times of uncertainty, a little cash never hurt anyone. Even better, cash held at money market funds can generate annual yields of over 4% at the moment.
🎯 Also On Our Radar
The senior loan officer opinion survey (or “SLOOS”) is a quarterly review conducted by the Fed to gather information on bank lending practices. The latest one covered the final quarter of 2022 and showed a significant increase in the number of banks tightening their loan standards. Put differently, the lending environment was deteriorating even before last quarter’s turmoil in the banking sector. So all eyes will be on the new survey, set to be released this Monday: it’ll offer a glimpse of the damage inflicted last quarter as the banking crisis unfolded.
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