Hike rates

Fed rate hike – troyrecord

The Federal Reserve’s Open Market Committee (FOMC), the body that determines monetary policy, including the direction of interest rates, concluded a regular two-day meeting last Wednesday during which they decided that A 0.75% increase in the Federal Debt Funds rate was necessary to combat the recent spike in inflation. This can be defined as the rate charged between FDIC member banks for overnight lending of excess reserves and is the basis from which many other interest rates are based.

This marks the third consecutive increase. Following meetings on March 15-16, May 3-4, and June 15-16, 2022, the Fed announced rate hikes of 0.25%, 0.50%, and 0.75%, respectively. The latter marks the biggest rise since 1994. Interestingly, 1994, a year in which the Fed raised the federal funds rate six times and the S&P 500 fell 1.54 %, paved the way for the second half of the 1990s. During this five-year period, the worst year for the S&P 500 was when it rose just over 20% and recorded a compound annualized growth rate of 26.18%.

The Federal Reserve’s official press release noted evidence that “inflation remains elevated, reflecting pandemic-related supply and demand imbalances, rising energy prices and higher pressures. wide on prices”.

The statement also referred to its dual statutory mandate which is to seek maximum employment as well as price stability, the latter being defined as an annual inflation rate of 2%.

To no one’s surprise, it is price stability that is holding the Fed in a bind. As measured by the consumer and producer price indices, retail and wholesale inflation increased by 1.0% and 0.8% in May and by 8.6% and 10.8% during of the last twelve months. Additionally, housing prices have jumped more than twenty percent over the same period, five times the historical average.

Several months ago, before Russia invaded Ukraine or China imposed its “zero tolerance” policy when it came to the fight against COVID in the country, we coined the word “secular” to describe our view of the nature of inflationary pressures that affect the consumer. We thought then that some of them would be somewhat temporary while others would be more long-lasting. Given the two unforeseen events noted at the top of this paragraph, our current view is that inflation will last a bit longer than initially expected, but ultimately at less than half of its current rate. We also believe that barring an additional black swan, inflation will peak in the third quarter as the drag from rising interest rates and quantitative tightening begins to set in.

A case for this can be illustrated by taking a look at mortgage rates. According to Bankrate, the average rate for a conventional 30-year fixed mortgage is around 6%. Assuming a $350,000 mortgage, the monthly payment would have increased by $622 or $7,464/year compared to a year ago, when interest rates charged on that same mortgage averaged 3% .

While we sincerely applaud the Fed’s recent stance on fighting inflation, in our view the Fed needs to be careful not to over-tighten as monetary policy operates with a lag. Moreover, higher interest rates will do little to correct supply chain disruptions other than by destroying demand. Too much will prevent the Fed’s long-sought soft landing. The Fed then meets on July 26 and 27, and again on September 20 and 21. Currently, we are forecasting fed funds rate hikes of 0.50% each time, but we hope that by September, enough evidence of an economic slowdown will have accumulated to necessitate a hike of just 0.25% during this meeting.

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