“Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.
Russia’s war against Ukraine is causing tremendous human and economic hardship. The war and related events are contributing to upward pressure on inflation and are weighing on global economic activity. The Committee is highly attentive to inflation risks.
The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 4-1/4 to 4-1/2 percent. The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.”
- Release from the Federal Reserve dated December 13, 2022
No One Was Surprised at Number 7
This seventh rate hike this year was one of the more predicted rate movement the markets have ever seen. And as the Fed continues moving rates higher over the next year, then we will continue to see some challenges for the stock market and consumers. And for now, the magnitude of those challenges is difficult to predict.
So, will there be implications of this announcement? Sure. But enough to make most investors change allocations or courses of action? That’s harder to say.
Reason to Change
The most important tool available to the Fed is its ability to set the federal funds rate, or the prime interest rate. This is the interest paid by banks to borrow money from the Federal Reserve Bank. Interest is, basically, the cost to the banks of borrowing someone else’s money. The banks will pass on this cost to their own borrowers.
Increasing the federal funds rate reduces the supply of money by making it more expensive to obtain. Reducing the amount of money in circulation, by decreasing consumer and business spending, helps to reduce inflation.
Effects for Consumers and Businesses
Any increased expense for banks to borrow money has a ripple effect, which influences both individuals and businesses in their costs and plans.
Effect on individuals– Banks increase the rates that they charge to individuals to borrow money, through increases to credit card and mortgage interest rates. As a result, consumers have less money to spend and must face the effect on what they want to purchase and when to do so.
In other words, mortgage rates are trending up and credit card interest rates are too. Same is true with auto loans.
Effect on business – Because consumers will have less disposable income (in theory), businesses must consider the effects to their revenues and profits. Businesses also face the effect of the greater expenses of borrowing money. As the banks make borrowing more expensive for businesses, companies are likely to reduce their spending. Less business spending and capital investment can slow the growth of the economy, decreasing business profits.
These broad interactions can play out in numerous ways.
Effects on the Markets
The stock markets – This one is a bit trickier because intuitively stock prices should decrease when investors see companies reduce growth spending or make less profit. The reality, however, is that the Fed typically won’t raise rates unless they deem the economy healthy enough to withstand what should – at least in textbooks – slow the economy. But the reality is that stocks often do well in the year following an initial rate hike. But after 7 rate hikes in the same year? Much tougher to predict.
Bond Market – If the stock market declines, investors tend to view the risk of stock investments as outweighing the rewards and they will often move toward the safer bonds and Treasury bills. As a result, bond interest rates will rise, and investors will likely earn more from bonds.
Obviously, many factors affect activity in various parts of the economy. A change in interest rates, although important, is just one of those factors.
Call your financial advisor if you have questions or want to discuss additional repercussions that this Fed rate increase will likely have. You can also reach me for your investment strategy and complimentary portfolio review at firstname.lastname@example.org and schedule online virtual meeting here, https://go.oncehub.com/SunheeLee
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