Federal Reserve delivers fourth consecutive outsized 0.75% rate hike in effort to cool inflation

November 2, 2022 | Market news

Key takeaways

  • The Federal Reserve increased interest rates by 0.75% for the fourth consecutive meeting in its ongoing attempt to cool inflation.
  • The official press release and Fed Chairman Jerome Powell both hinted future rate hikes may slow but noted new data since its September meeting implies rates may need to rise higher than previously expected.
  • Bond market prices imply expectations that the Fed’s target interest rate will peak around 5% in the first half of next year from the current range of 3.75% to 4.00%.

As markets expected, the U.S. Federal Reserve (Fed) increased its target federal funds interest rate, the primary tool it uses to carry out maximum employment, stable prices and moderate long-term interest rates mandates, by 0.75% to a range of 3.75% to 4.00% following its regularly scheduled two-day meeting. Inflation has slowed from a 40-year high above 9% to just above 8%.

Despite slower inflation, ongoing price gains well above Fed target levels remain a catalyst for aggressive Fed tightening. The labor market remains tight (evidenced by 10 million unfilled job openings) and wage growth elevated, adding to the concern inflation is stuck at a high rate. The Fed typically changes policy rates in 0.25% increments; today’s fourth consecutive 0.75% increase, preceded by a 0.50% and an initial 0.25% increase earlier this year, highlights the Fed’s resolve to fight inflation, despite the swoon in stock and bond prices.

Investors’ attention focused on Fed Chairman Jerome Powell’s press conference, since the Fed did not update its Summary of Economic Projections, last released in September. Leading up to today’s announcement, investors and the financial media speculated the Fed could call for a slower pace to future rate hikes, which contributed to a recent bounce in stock and riskier bond prices along with the dollar falling from recent peak levels. Through both its prepared statements and responses to media questions, the Fed delivered a nuanced message. The official statement noted likely additional increases while considering cumulative hikes to date (which have been considerable at 3.75% so far this year) and the lag between rate hikes and when they affect the economy. That lag can be “long and variable,” as Chairman Powell noted later during the press conference, defining “long” as between 12 to 18 months. Powell also stated, “incoming data since our last meeting (on September 21) suggests that the ultimate level of interest rates will be higher than previously expected.” Perhaps the most important comments Powell made were that “it is very premature to be thinking about pausing (rate hikes)” and “we have a ways to go.” He concluded the press conference by stating the more restrictive policy needed “narrows the path of a soft landing.”

The Fed remains in the early stages of reducing its $8.5 trillion in Treasury and mortgage bond holdings, originally accumulated to suppress interest rates in response to the global pandemic’s outset. The Fed previously announced it would allow up to $95 billion per month to mature, forcing investors to absorb the incremental supply. In addition to restraining post-pandemic bond yields and encouraging borrowing, the Fed’s bond buying also replaced bond holdings with money, which can support economic activity through added liquidity. Thus far, the Fed’s balance sheet has shrunk by a small amount, but the continuing bond portfolio runoff could nudge bond yields higher (which move in the opposite direction of bond prices) and dampen liquidity, in turn reducing a portion of the fuel available for future economic growth.

Stock prices initially rose after the announcement but fell after Powell noted it is “very premature to be thinking about pausing (rate hikes).” The S&P 500 finished down 2.5%. Ten-year Treasury yields remained elevated, near 4.08%, below recent highs near 4.25% but still near the highest yield in 14 years. Likewise, the two-year Treasury yield near 4.61% remains near the highest level in 15 years. Higher bond yields and interest rates reflect higher borrowing costs, which can dampen economic activity.

Monetary policy, defined as central bank interest rate target decisions, continues tightening around the globe as high food and energy prices begin spilling over into prices of other items, particularly services. This year’s first three quarters each set consecutive records for the most net rate hikes (the number of central banks raising interest rates less those lowering rates) across the 60 central banks we track since 2004. The initial pace of fourth quarter net rate hikes implies a reversion to lower levels, though still rapid relative to history. In addition to ongoing policy tightening and tighter liquidity noted earlier, consensus expectations indicate subdued global growth for upcoming quarters. Recent purchasing manager surveys affirm the weak growth estimates.

Slower growth, higher inflation and tighter monetary policy are weighing on corporate earnings. Third quarter corporate earnings appear mixed, and many companies have remained tight-lipped on 2023 guidance. We retain a more defensive portfolio bias, anticipating ongoing volatility in the near term, and see opportunities in high-quality bonds and global infrastructure investments relative to stocks. Within bond allocations, retaining high-quality bond exposure represents a critical portfolio component to manage portfolio risk, particularly now that higher bond yields better reflect expectations for ongoing aggressive central bank rate hikes.

As always, we value your trust and are here to help in any way we can. Please do not hesitate to let us know if we can help address your unique financial situation or be of assistance.

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