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Another big hike: U.S. Federal Reserve pushes target rate range to 3.75%-to-4.00%

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Key messages

  • The target range for the federal funds rate was increased by 0.75%.
  • Inflation remains stubbornly high.
  • Rates are expected to go higher still in ongoing fight against inflation.

Members of the Federal Open Market Committee unanimously voted to increase the target range for the federal funds rate by 0.75% on Wednesday afternoon. This brings the U.S. Federal Reserve’s (Fed) target range to 3.75%-to-4.00%. The fed will also continue to lower its holdings of treasury securities, agency debt and mortgage-backed securities. The move was widely in line with market expectations.

Beyond repeating that it anticipates further increases to be appropriate, the Fed did add that these hikes are to attain a monetary policy position that is “sufficiently restrictive” to tame inflation back to its 2% long-term target. To determine future moves, the Fed added that it will consider: the cumulative tightening of policy; the lag in which policy affects economic activity and inflation; as well as future economic and financial developments.

Some believe this opens the door for the Fed to stop raising rates even if inflation remains high should signs indicate that the financial strain of higher rates is too intense.

More hikes to come

The Fed’s announcement is still consistent with its rate expectations released in September. This suggests another 0.5% hike before the end of the year. As a reminder, the Fed expects the median federal funds rate to be 4.4% by the end of 2022, 4.6% in 2023, 3.9% in 2024, 2.9% in 2025 before settling at 2.5% longer term.

If it wasn’t obvious before, the Fed repeated once again that it remains focused on reigning-in inflation. The Fed’s expectations for inflation are 5.4% for 2022, 2.8% for 2023 and 2.3% for 2024. The Fed still expects to achieve it’s 2% inflation target by 2025.

Drivers of inflation remain

Taken from the Fed’s announcement, “recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.” Additionally, regarding the invasion of Ukraine, “the war and related events are creating additional upward pressure on inflation and are weighing on global economic activity.”

We remain cautiously positioned

The S&P 500 Index was flat leading up to the 2:00 pm announcement. Despite the move being widely expected, U.S. equities jumped immediately following the press release on hopes that light is near in the rate hike tunnel. However, equities traded lower shortly after as Fed Chairman Powell clarified that “it’s very premature to be thinking about pausing [rate hikes]” and that “we have a ways to go.”

The U.S. dollar and U.S. bond yields saw similar see-saw action with the U.S. dollar trading higher against the Canadian dollar (and most major currencies) and bond yields climbing further by the end of the trading day.

Recently, we increased our allocation to equities, but we remain underweight overall in our portfolios. Stock markets have sold off meaningfully as inflation remains high. As financial conditions continue to tighten to fight inflation, the fundamental outlook for the economy continues to weaken. However, the risks of being underweight equities has increased materially as positioning for a recession is now the consensus trade. Therefore, it is prudent to increase our position in equities while remaining underweight overall in the near term.

On the fixed income side, we continue to target a flatter yield curve (short-term bond yields have risen more than longer-term bond yields) and a slightly long duration (interest rate sensitivity) bias in North America.

For more information about this announcement or your portfolio, please contact your MD Advisor*.

If you are wondering how rising rates will impact your finances beyond your investments, here’s what it could mean for you.

The Fed’s next interest rate announcement is scheduled before the end of the year on December 14, 2022. It will be accompanied by updated economic projections.

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.

The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.

About the Author

Richard Schmidt, CFA, is an Associate Portfolio Manager with the Multi-Asset Management Team of 1832 Asset Management L.P. His primary focus is MD’s North American equity funds and pools.

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