The U.S. Federal Reserve votes to increase interest rates by 0.75%
- The range for the federal funds rate was increased by 0.75% to 1.50-to-1.75%.
- The Fed will continue to reduce the size of its balance sheet.
- The Fed is hawkish: Further rate hikes are coming.
In seeking maximum employment and average 2% long-run inflation, the U.S. Federal Reserve (Fed) announced that it would raise the target range for the federal funds rate by 0.75%, its largest hike since 1994. The target range is now 1.50-to-1.75%. Interestingly, one voting member of the Federal Open Market Committee voted for a 0.50% increase.
The Fed also reiterated that it “anticipates that ongoing increases to the target range will be appropriate” and that it will “continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities.”
The Fed is strongly committed to returning inflation to its average 2% objective
In its latest economic projections published alongside the rate hike announcement, the Fed’s expectations for inflation were revised up to 5.2% for 2022 (from 4.3% in March), down to 2.6% for 2023 (from 2.7%) and down to 2.2% for 2024 (from 2.3%). Longer term, the Fed still expects inflation to normalize to its average 2% target.
The Fed again cites ongoing demand and supply imbalances related to the pandemic, higher energy prices, and broader price increases brought about by the invasion of Ukraine by Russia, as the primary causes for elevated inflation. Copied over from its May announcement, the Fed stated “the invasion and related events are creating additional upward pressure on inflation and are weighing on global economic activity. In addition, COVID-related lockdowns in China are likely to exacerbate supply chain disruptions.”
U.S. GDP growth revised down in the near term but remains positive
After shrinking in the first quarter, the U.S. economy appears to have picked up some slack. Additionally, job gains have been robust, and unemployment remains low. Despite this turnaround, expectations for growth were revised down to 1.7% from 2.8% for 2022, 1.7% from 2.2% for 2023 and 1.9% from 2.0% for 2024.
Interest rates marching higher, faster
From the latest economic projections, the Fed expects the median federal funds rate to be 3.4% by the end of 2022, 3.8% in 2023, 3.4% in 2024 and 2.5% longer term. This is a substantial bump up from the projections published in March – 1.9%, 2.8%, 2.8% and 2.4%, respectively.
Reaction to the announcement was fairly limited as the market spent the first part of the week pricing-in the larger rate hike (trading lower). The S&P 500 Index was already trading higher on Wednesday prior to the news and continued to do so following the 2 p.m. announcement. U.S. bond yields remained elevated across maturities and the U.S. dollar depreciated versus other major currencies.
Positioning portfolios appropriately given current risks
We remain overweight cash and underweight equities in our portfolios as financial conditions and monetary policy continue to tighten and risks associated with the pandemic and the invasion of Ukraine persist.
We are slightly overweight U.S. equities and underweight Canadian equities, international equities, and emerging market equities.
Regarding fixed income, we continue to target a flatter yield curve in Europe (the European Central Bank is likely to move away from emergency-level rates soon) and a slightly long duration (interest rate sensitivity) position in North America (we expect longer-dated yields to come in from current levels as central banks tighten lending conditions amidst slowing economic growth).
While interest rates have risen materially in 2022, it is important to remember that rates remain low historically. However, if you are wondering how rising rates will impact your finances beyond your investments, here’s what interest rate increases could mean for physicians. If you have any questions about this announcement, our positioning or how it will impact you, please contact your MD Advisor*.
The Fed’s next interest rate announcement is scheduled for July 27, 2022.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec).
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.