The Federal Reserve made a unanimous decision to increase the federal funds rate by 25 basis points yesterday, resulting in a range of 4.75% to 5%, the highest since 2007. Prior to the meeting, there was much debate on the direction of interest rates due to the financial sector’s recent troubles.
The main questions were whether the fed funds rate would increase, decrease, or remain the same and whether they would continue to rise after the meeting. Furthermore, there was the common question about whether the Federal Reserve perceived any further advancements in the fight against inflation. As usual, the responses to many of these questions were nuanced, but we were able to discern some clues from their policy statements and remarks. In their policy statement, they mentioned that additional policy firming may be appropriate, indicating the possibility of further rate hikes. This was a significant change from their previous eight statements, where they mentioned ongoing increases being appropriate. However, the more important point they made was that a cut in interest rates is highly unlikely for the current year. This announcement comes as a surprise to many investors who had already priced in a rate cut or two before the year’s end.
Moreover, they recognized the potential impact of recent banking stress on the economy, which could result in tighter credit conditions, and consequently, reduced monetary policy actions such as fewer interest rate hikes. Additionally, they mentioned that they were uncertain about the extent to which the recent banking stress would dampen the economy, but they expressed confidence in the stability and strength of the US banking system.
Finally, regarding inflation, the Federal Reserve commented on three primary components of inflation. Firstly, they discussed goods inflation, which has been decreasing for the past six months, but at a slower pace than desired. Nevertheless, progress is being made in this area. Secondly, they mentioned housing services inflation, which they believe will decline as time passes, given that new leases are being signed at levels below inflation. Housing services inflation accounts for around 20% of the PCE report, the Federal Reserve’s preferred measure of inflation. Thirdly, they noted that non-housing services inflation has not shown significant improvement. However, they anticipate that this will decrease as demand softens and potentially with a softening in labor market conditions.
Overall, although some progress has been made, inflation has not changed much, and more work needs to be done. Regarding concerns about banking stress, the Federal Reserve believes that banks are stable enough to weather the higher rate environment, and therefore there is no real cause for concern. Lastly, it was announced that a reduction in interest rates is unlikely for the current year. While it is still uncertain on whether they will keep hiking, it appears that they will continue with their usual approach of reacting to incoming data and remaining vigilant regarding recent banking stress tremors. For the week, the S&P 500 and Dow Jones Industrial Average are down 0.27% and 0.44%, while the Nasdaq is up 0.61%, respectively, as of today’s close.
Andrew Ochoa, AIF®
Portfolio Administrator