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U.S. Fed rate hike implications for portfolios
The US central bank announced a quarter percentage point increase in its benchmark rate overnight, which was widely expected. For the first time in three years has it increased rates and it expected to keep this going until they reach between 1.75 percent and 2 percent by the years end.
Sonal Desai, CIO of Global investment firm, Franklin Templeton Groups says, “I am surprised that the hiking cycle is as short as it appears to be. In addition, the terminal rate has not changed at 2.8%, which means we will end the hiking cycle with real rates barely positive (using Fed’s own forecasts). Not clear what actually brings inflation down as quickly as is anticipated given this.”
Bill Zox, CFA, Portfolio Manager, Brandywine Global also commented on the issue saying, “The Fed does not seem concerned about interest rate volatility or the recent declines in financial assets. The Fed dot plot for the next year or so did roughly match what financial markets were discounting. It seems to me that the Fed is leaving it to financial markets to dictate the path of the fed funds rate. That approach will lead to more interest rate volatility than if the Fed were engaged in more of a two-way interaction with the financial markets. I suspect that incoming economic data will be volatile and the financial market reaction to that data will also be volatile.
So my sense is more of the same for financial markets until the data suggests that inflation is coming back down. If investment grade bonds, high yield bonds and stocks do continue to decline, we may find out when the Federal Reserve is willing to get more involved in a two-way interaction with the financial markets.”
“The Fed release today is unsurprising – they are clearly on a path to higher rates, which the bond market at least seems to recognize. The equities market appears more uncertain about the balancing act between inflation, geopolitics and economic growth, and the range of views among investors is quite wide. We believe that for now, at least, the Fed needs to signal it is willing to fight inflation, and it can make adjustments to the pace of hikes in the coming months as developments warrant,” adds Patrick S. Kaser, CFA, Managing Director & Portfolio Manager, Brandywine Global.
The dot plot does show that inflation will drop back to 4.3 percentage up from 2.6 percent in December together with GDP growth of 2.8 percent. In 2023, predictions are for rates to continue to move upward and then stop, with inflation remaining above 2 percent leading into 2024.
Josh Jamner, ClearBridge Investments, Investment Strategy Analyst, says “The Federal Reserve kicked off a tightening cycle today, raising the Federal Funds rate by 25 basis points, consistent with market expectations. The “Fed Dots” or Statement of Economic Projections, also came in consistent with market pricing for the total number of interest rate hikes this year, at six to seven or a nearly 2% Fed Funds rate. Chairman Jay Powell commented during his press conference that inflation is likely to remain higher for longer and economic growth to come in slower given supply chain entanglements and commodity price increases emanating from the Russia-Ukraine situation.”
“Financial markets digested this information well with equities rallying, long-term interest rates remaining largely stable, inflation expectations dropping and credit spreads narrowing. Given that the Fed’s actions were largely expected and no major surprise occurred, a positive market reaction is a welcome development,” says Jamner.
