What a Difference a Year Makes
A year ago, the federal funds rate was close to zero, consumer price inflation reached 7.9%, and yet the 10-year Treasury yield was 1.79%. What a difference a year makes. Inflation clearly had more upside and from this vantage point, the Federal Reserve (Fed) was late in pursuing price stability.
As expected, the Federal Open Market Committee (FOMC) raised target rates yesterday by just 0.25% to a range of 4.50%–4.75%. After raising rates at the fastest clip since the 1980s, today’s fed funds rate is the highest since 2007. The rapid rise in rates has indeed tamed inflation. After reaching a peak last year, inflation rates have clearly decelerated as tighter financial conditions and better supply chains have both reversed the inflation trend.
Fed Talks about Ongoing Increases
According to yesterday’s statement, the FOMC is comfortable accepting that inflation has eased, which is a micro-step toward a pause later this year. The FOMC statement reveals the Committee’s commitment to “ongoing increases in the target range” so the end of the hiking campaign will not likely happen until the second quarter. Investors should expect the Committee to raise rates at least one more time.
As shown in the chart below, the fed funds upper bound is higher than the latest reading on the core deflator, the first time since the beginning of the global pandemic. As inflation cools and the economy slows, the Committee’s approach to the dual mandate will evolve and that evolution has already started with this recent decision. When investors compare the current statement with last year’s, investors should conclude the days of any hikes greater than 25 basis points (0.25%) are over for this cycle. It seems the Committee no longer worries about the “pace” but is now focused on the “extent” of future increases.
After the latest decision, the fed funds upper bound is higher than the latest reading on the core deflator. Inflation is poised to ease further in the coming months, which will give the Fed some leeway to end its rate hiking campaign. The FOMC will likely hike rates again by 0.25% on March 22, but the debate builds about potential decisions made on May 3 (our best guess at this point is the Fed pauses in May). And most importantly, investors should remember that history shows that markets respond favorably after the end of a rate hiking cycle.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. For more information on the risks associated with the strategies and product types discussed please visit https://lplresearch.com/Risks
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
Unless otherwise stated LPL Financial and the third party persons and firms mentioned are not affiliates of each other and make no representation with respect to each other. Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
Securities and advisory services offered through LPL Financial, a registered investment advisor and broker-dealer. Member FINRA/SIPC.
Tracking # 1-05358463