- The target range for the federal funds rate is now 0.25-to-0.50%.
- Further rate increases are coming.
- Inflation remains uncomfortably elevated.
As widely expected, the U.S. Federal Reserve (Fed) announced on Wednesday afternoon its first rate hike since 2018, increasing the target for the federal funds rate to 0.25-to-0.50%. In its statement, the Fed noted that it expects further increases to be appropriate, as is reducing its Treasury security and agency mortgage-backed security holdings at upcoming Federal Open Market Committee meetings.
Russia-Ukraine conflict: Negative for global growth, boost for inflation
The implications of the conflict for the U.S. economy is uncertain at this time, but as my colleague Wesley Blight noted earlier in the month, the invasion of Ukraine by Russia is likely to push prices and inflation higher. It will also increase market volatility, which we’ve already seen, and will weigh on global economic growth.
Economic indicators remain strong while 2022 growth is revised downwards
The Fed announced that “indicators of economic activity and employment have continued to strengthen.” Furthermore, that “job gains have been strong in recent months, and the unemployment rate has declined substantially.” Nonetheless, in light of stubbornly high inflation and global sanctions on the Russian economy, the Fed revised 2022 growth down to 2.8% from 4.0%.
Inflation still stubbornly high
While the Fed still believes inflation will normalize towards its 2.0% target over the long term, inflation remains elevated, with pandemic-related demand and supply imbalances, higher energy prices and the conflict in Ukraine all playing a role. In its latest projections, the Fed revised its expectations for inflation higher for 2022 (4.3% from 2.6%), 2023 (2.7% from 2.3%) and 2024 (2.3% from 2.1%).
More rate hikes ahead
The Fed now projects the median federal funds rate to be 1.9% in 2022, 2.8% in 2023, 2.8% in 2024 and 2.4% longer term. This is materially higher than what was projected at the end of 2021, as the Fed looks to address the inflation issue. This implies six more hikes this year and three more in 2023, up from the previous forecast of three hikes for each year.
After trading higher throughout Wednesday, the S&P 500 index fell nearly 1% following the announcement but more than recovered to close the day over 2% higher than one day prior. Similarly, U.S. bond yields rose across maturities and the U.S. dollar appreciated vs. other major currencies, before reversing course as market participants digested the news.
Lowering portfolio risk
Earlier in the week, we reduced our overall allocation to equities to lower portfolio risk but remain overweight overall. Our base case for slower growth remains and the risk of recession has risen, particularly in the Eurozone. The U.S. and China are still well positioned to manage increasing commodity prices which should allow the global economy to avoid a broader contraction. That being said, China’s commitment to their zero-COVID policy continues to weigh heavily on its markets and overall economy.
While we reduced our weights, we remain overweight U.S. equities, slightly overweight Canadian equities, underweight international equities and neutral emerging market equities.
We have further increased our underweight to cash in order to increase our allocation to fixed income, targeting expected moves in the U.S yield curve and to achieve a lower overall portfolio risk.
For more information about the Fed announcement, our positioning, or your portfolios, please contact your MD Advisor*.
The Fed’s next interest rate announcement is scheduled for May 4.
* 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.