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Unsurprisingly, the U.S. Federal Reserve raises interest rates again

Front view of the federal reserve building of the United-States.

Key takeaways

  • The target range for the federal funds rate is now 0.75-to-1.00%.
  • The Fed will begin reducing its balance sheet on June 1.
  • Further rate hikes are likely as the invasion of Ukraine and pandemic-related lockdowns in China fuel inflation.

In a statement that was similar to its March announcement, the U.S. Federal Reserve (Fed) decided that it would raise the target range for the federal funds rate by 0.50% to 0.75-to-1.00% this week. The Fed also reiterated that it “anticipates that ongoing increases in the target range will be appropriate.” Consistent with its March statement, The Federal Open Market Committee outlined its plans to reduce its holdings of Treasury and agency mortgage-backed securities, commencing on June 1st.

Inflation remains a key influence

With the appropriate adjustments to its monetary policy, the Fed still expects long-term inflation to normalize around its 2% objective. However, inflation remains elevated in the short term, “reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.” As a reminder, the Fed expects inflation of 4.3% for 2022, 2.7% for 2023 and 2.3% for 2024.

The ongoing Russian invasion of Ukraine will likely continue to put upward pressure on inflation and is likely to hinder global economic activity. Sanctions against Russia have effectively cut much of the developed world off from the second largest oil producer. Similarly, Russia and Ukraine represent approximately a quarter of the world’s wheat exports and Russia and the closely related Belarus, the bulk of global potash exports. The Fed repeated that the implications for the U.S. economy are highly uncertain.

Also worth mentioning, pandemic-related lockdowns in China are likely to fuel supply chain disruptions and inflation as it continues to pursue its dynamic zero-COVID policy.

U.S. GDP shrinks but other indicators remain positive

The U.S. economy shrunk for the first time since the first quarter of 2020, at the beginning of the pandemic, declining 1.4% over the quarter. Despite this, “household spending and business fixed investment remained strong. Job gains have been robust in recent months, and the unemployment rate has declined substantially.”

Interest rates to move higher

From the latest economic projections, the Fed expects the median federal funds rate to be 1.9% in 2022, 2.8% in 2023, 2.8% in 2024 and 2.4% longer term.

After trading flat all day, the S&P 500 index responded positively following the Fed’s announcement, climbing nearly 3% to close the trading session. Much of the jubilation occurred outside of the prepared remarks when Fed Chairman Powell answered a press conference question by stating that the Fed is currently not considering 0.75% hikes. Additionally, U.S. bond yields remained elevated across maturities and the U.S. dollar depreciated vs. other major currencies.

Nonetheless, despite the positive initial reaction, equity markets sold-off substantially the following day, with the S&P 500 Index down over 3.5%, following the Bank of England’s outright admission that they’ll be looking to induce an economic slowdown to cool inflation.

Since the Fed’s March announcement, we have reduced the risk in our portfolios by moving to a small underweight position in equities. We are slightly overweight U.S. equities, slightly underweight Canadian equities, underweight international equities and neutral on emerging market equities. The Fed’s announcement supports our view as financial conditions and policy continue to tighten and long-term economic risks continue to increase.

On the fixed income side, we remain interest rate neutral and continue to target a flattening of the U.S. yield curve.

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 June 15, 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.

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.

Profile Photo of Richard Schmidt