Fed Hikes Rates Again But Has The Raising Cycle Ended?

Key Takeaways

• The Fed has increased their base interest rate by 0.25%, in line with expectations despite the uncertainty in the financial sector
• Chairman Jerome Powell made a number of comments which suggest the rate hike cycle could be slowing, but made it clear that cuts are not in the plan for this year
• Markets sold off in the afternoon of the announcement, but bounced on Thursday morning with the S&P 500 up around 1.50% in morning trade

If you’d asked just about anyone a month ago what the Fed would do at the next Federal Open Market Committee (FOMC) meeting, a rate hike wouldn’t have been a question. Maybe some would have said 0.25%, a reasonable number would have said 0.50%, but no one would have predicted a pause or a fundamental change to the monetary tightening.

Then banks started collapsing.

Unsurprisingly, that type of event tends to have a pretty major impact on the Fed’s decision. And in turn, those decisions can be a big deal for investors, especially right now as markets are moving heavily in line with the interest rate decisions.

In the end, it was a 0.25% hike that the Fed went ahead with, but many analysts were expecting a pause in rate hikes in order to provide the market with some breathing move. The reality is that this could have seriously backfired, rocking confidence in the market and sending stocks.

As it happened, stocks sold off anyway in late hours trading on Wednesday, with the S&P 500 finishing the day down 1.68% after climbing steadily in the lead up to the announcement. However it rebounded swiftly on Thursday morning, with the broad index up around 1.50% in morning trade.

With the Fed making noises about slowing their rate hikes (more on that below), it could be good news for markets which have sold down through the tightening rate cycle.

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The Fed’s decision and comments

While there were some dissenting opinions (including Goldman Sachs and Moody’s) believing we’d see a pause in the Fed’s tightening monetary policy, the majority of analysts believed that the Fed would continue with a 0.25% rate hike.

As usual for the Fed these days, they found themselves in a difficult position. On one hand, the market has been rocked in recent weeks due to the instability in the banking sector, and some respite from the increase of borrowing costs would allow some further breathing space while the dust settled.

On the other hand, the Fed, the regulators and the government have all been very clear in their message that the financial system is safe and secure. A pause in rate rises could have created the opposite impact than its intention, by panicking the market, believing that the Fed must be more worried than they’re letting on.

That’s particularly true given how strongly chairman Jay Powell has stated their intentions to bring down inflation at all costs.

In the end, the clearest path forward was to ‘keep calm and carry on’ with a rate rise of 0.25 percentage points.

But what was more interesting was Jay Powell’s comments.

He made it clear that rate cuts are not in the plan for this year. But the fact that he was even talking about rate cuts is telling, and suggests that rate hikes, at least, may not continue for too much longer.

Powell also stated that he believes the banks are likely to do some of the Fed’s work for them, cutting lending as a way to manage risk in the wake of the wobbles of recent weeks:

“I think for now, though…we see the likelihood of credit tightening. We know that that can have an effect on the macro economy,” he said.

What’s next for interest rates?

Obviously it depends on economic data that is released, such as employment reports and, of course, inflation. Jay Powell has still stated that the aim for the Fed is to get the inflation rate down to 2%, and it’s still over three times this level.

The difference is that his comment suggests that we’re closer to that figure than the data currently suggests.

So while it may feel like there are many months of high inflation still to come, it could be that the figures start to turn quickly over the coming months. If this was to happen and we saw some major falls in the annual rate of rising prices, it could allow the Fed to keep rates steady and let the trajectory of economic growth and inflation run its course.

This is helped along by the fact that the financial sector is being very cautious right now. The whole point of raising rates is to make borrowing more expensive, which slows down consumer spending and economic growth.

But if the banks are nervous about lending on their own, regardless of further rate hikes, then the end result of lower spending could be met just through the banks own business decisions, without prompting from the Fed.

Either way, we shouldn’t expect major rate cuts anytime soon. Jay Powell made it clear that cuts are in the Fed’s “baseline expectations,” even though the futures market is currently pricing in pretty significant cuts of around 100 basis points.

What does this mean for investors?

In general, rate hikes are not good for investors. Higher rates means lower spending, and lower spending means lower profits. That’s not what anyone wants to hear from their company’s quarterly earnings call.

In contrast, rate cuts have a stimulating effect on the economy, which is generally seen as a good thing for stocks as they are faced with the prospect of higher potential sales and revenue.

We’re likely to see the market follow this narrative for the time being, barring any further major banking issues or something else coming in from left field. So if and when the Fed pauses their rate hikes, stock markets could rally on the hope that it’s a turning point in the tightening cycle.

Of course this all comes back to expectations. If markets expect a rate cut and the Fed instead simply pauses hikes, the market could move in the opposite way.

The bottom line

One thing is for sure, and that’s the fact that we’re likely to continue to see volatility in the markets. There are a number of macroeconomic factors (like interest rates and inflation) which are moving markets generally, and more specifically at a company level there are plenty of big issues too.

The tech race for AI, banking instability and even ongoing issues around Russia and the war in Ukraine all have the potential to cause havoc in specific sectors and industries.

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