Fed dials it up
- Fed gets more aggressive with biggest hike in nearly 28 years
- Increase brings fed funds rate to 1.5%–1.75%
- Consumer sentiment playing role?
Wednesday afternoon the Federal Reserve raised interest rates for the third time since March, hiking the benchmark fed funds rate by 0.75% to a target range of 1.5%–1.75%. It was the first time since November 1994 that the Fed hiked rates by 0.75%.
The move reflected a more aggressive inflation-fighting posture from the central bank, which until very recently was widely expected to raise rates by only 0.5%. But data released over the past several days, including a larger-than-expected jump in the Consumer Price Index (CPI), may have tilted the scales in favor of a 0.75% increase.
When the Fed raises interest rates, auto loans, credit card rates, and mortgages become more expensive for consumers, while businesses also pay more to borrow the money they need to fund operations or expand. That can make both consumers and businesses more conservative about spending—which may then cool the economy and, hopefully, drive down the prices of goods and services.
The challenge is to accomplish this goal without tipping the economy into recession. For investors and traders, a more immediate question may be whether the stock market—currently in its biggest downturn since March 2020—is likely to see more downside as the result of higher rates.
The following chart shows the market rallied for nearly two weeks after the Fed’s March 16 rate hike, but turned lower after the May 4 increase (although it closed sharply higher the day of the announcement):
Source: Power E*TRADE. (For illustrative purposes. Not a recommendation.)
As this chart suggests, the short-term outcome of a Fed rate hike is often volatility. Longer term, though, the correlation between rising interest rates and falling stock prices is not as strong as many people think. For example, the SPX rallied during the last two Fed tightening cycles (June 2004–June 2006 and December 2015–December 2018).
However, past rate-hike cycles occurred in market environments that may not have had much in common with today’s. Morgan Stanley & Co. recently described the role flagging consumer sentiment—driven in large part by inflation concerns—is playing in the current market. In identifying 3,400 as a support level for the S&P 500 (SPX), their analysts described historically low consumer sentiment as a risk to the economy and the stock market—something that, along with still-hot inflation data, could keep the Fed aggressive.1
Their takeaway for investors: Stay defensive (emphasizing utilities, health care and REITs) until the market’s price or earnings expectations come down further.
Note: The Fed’s next policy meeting is scheduled for July 26-27.
1 MorganStanley.com. The Decline in Consumer Sentiment. 6/10/22.