The Federal Open Market Committee just hiked its federal funds rate target another 75 basis points (bps; 100 bps equal 1.00%), to a range between 3.00% and 3.25%. Hiking rates aggressively is risky when housing is already struggling and when what the Federal Reserve (Fed) does today might not be fully felt for dozens of months into the future.
Rate hikes of 75 bps were supposed to be “unusually large,” but now they’ve become standard fare. If there are too many more, the shock and awe approach to hiking could be awful for the economy. Thankfully, the Fed knows that, too, and it’s likely to throttle back the pace of hikes now that the market has started believing the message that the Fed wants to hike and hold at a fairly high rate. The Fed is trying to cool demand without killing it. In its policy statement, it said there are some signs of economic weakness, but the economy is broadly doing well and inflationary pressures are slowly receding.
While progress has been made in the fight against inflation, the fight isn’t over. The Summary of Economic Projections the Fed provided reinforced the message that the Fed wants to hike and hold rates at a fairly high level (around 4.5%) at least through the next year. The market has gotten the Fed’s message about hiking and holding. Back in March, the market was pricing in the idea that the Fed would hike but then retreat in April, when the full brunt of the force of rate hikes was expected to hit the economy. Now, the market is pricing in that the Fed might not flinch in the face of broader economic weakness.
The bad news is that an obstinate Fed might not be great for the growth outlook. The good news is that it should be good for the inflation outlook. Rates have reset higher, which is attractive for the fixed income market since falling inflation likely keeps a lid on how high longer-term rates will go. Decent coupon income with a bit more rate stability should be good for bonds. Equities might have a rougher road ahead as investors try to figure out how resilient earnings can be.
Within the next few months, we expect a “boring” balanced portfolio between stocks and bonds could be more attractive. Boring could be great again.
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