Fed makes good on hike

Market Perspective: E*TRADE from Morgan Stanley 07/26/23

The Federal Reserve consistently telegraphed that rates would go higher, and today they made good on their promise, raising the fed funds rate 0.25% to a target range of 5.25%-5.5%—the 11th hike since March 2022:

Chart 1: Fed funds rate, January 2020–July 2023. Fed hike 0.25% to 5%-5.25%.

Source (data): Federal Reserve. Values represent upper end of fed funds target range. (For illustrative purposes. Not a recommendation.)

When the Fed raises rates, auto loans, credit card rates, and mortgages become more expensive, while companies pay more to borrow money. 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 Fed’s ongoing challenge is to accomplish this goal without tipping the economy into recession.

Although the economy has slowed considerably, inflation is still above target levels. The Fed has remained wary of turning too dovish, too soon—something it believes could result in a resurgence of inflation. Also, despite some signs of loosening, the labor market remains resilient—an inflationary threat the Fed has repeatedly targeted in its communications. Regardless of whether another rate hike occurs this year, there is still no indication rate cuts are likely until sometime in 2024 at the earliest.

The Fed has stressed it intends to play the long game in its inflation battle, which will require patience from investors looking ahead to lower interest rates. On the plus side, a higher-interest-rate environment offers investors meaningful fixed-income yields. Sticking to a portfolio of quality stocks (those with proven cash flow, and/or a record of consistently raising dividends) and fixed-income investments should remain an attractive strategy for long–term investors.

Note: The Fed’s next policy meeting is scheduled for September 19-20.


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