As expected, after maintaining the Federal Funds Rate (FFR) near zero since the beginning of the pandemic, the U.S. Federal Reserve acted on March 16, 2022 and increased the benchmark interest rate by 25 basis points.
That will bring the FFR into a range of 0.25%-0.50% and immediately inch financing costs higher for many forms of consumer borrowing and credit. The Federal Reserve generally calls an FFR between 2.0% and 2.5% neutral. As can be seen from the chart below, even with the recent increase, interest rates are still incredibly low. That's another way of saying that current momentary policy is still incredibly accommodative.
Fed Funds Rate (FFR)
But the Fed's temporary monetary accommodation will now be removed from the economy in an effort to curtail inflation and normalize interest rate policy to pre-pandemic levels. In the press conference following the Fed's mid-March meeting, Jerome Powell validated market assumptions for just how far the U.S. central bank will need to go to control inflation. Officials indicated an aggressive path ahead, with rate rises anticipated at each of the remaining six meetings in 2022.
When the Consumer Price Index (CPI – which measures a wide-ranging basket of goods and services) was released on March 10th, it revealed worsening inflation in February amid the escalating crisis in Ukraine, continued supply chain hurdles, and continued strong demand. February's 7.9% annualized inflation rate marked a fresh 40-year high since January 1982, according to the Labor Department's Bureau of Labor Statistics. 1
Earlier in the year, in order to get a jump start on the fight against inflation, markets suggested that a 50-bp increase to the FFR was possible. That possibility became an impossibility after Russia invaded Ukraine and the ensuing volatility rocked global financial markets. We believe volatility will continue until there is a resolution to the Russia/Ukraine conflict. As the conflict persists, financial conditions will remain tight from elevated energy and commodity prices, which could in turn spark slower economic growth.
Recently, Sam Stovall, Chief Investment Strategist at CFRA Research, made the following observation. Since WWII, after the initial rate increase of a rate tightening cycle, the S&P 500 typically got off to a slow start in the subsequent 1, 3, 6 and 12-month periods, posting average price changes of -0.5%, -1.7%, +1.2%, and +4.9%, respectively.
However since 2011, with the advent of a more transparent Fed making advance announcement of changes to the FFR, the S&P 500 has rebounded more quickly in rate tightening cycles, posting average price changes of -3.1%, -0.8%, +6.4%, and +12.2% in the 1, 3, 6 and 12-month periods respectively. So, while many market technicians may scare the investing public with talk of a more hawkish Fed, rate tightening as a result of an expanding economy has more recently been a generally positive thing for equity investors. 2
Being a Fed-watcher for the better part of 30 years, I would be very surprised if the Fed could complete 6 straight rate hikes without a pause to account for some as yet unforeseen geopolitical or economic event. Many times the rhetoric at the outset is more bearish than the reality. Regardless, rate increases are coming.
The Russia/Ukraine conflict may be one of those geopolitical events that could reduce the Fed's desire to raise rates at the accelerated pace the market is currently projecting. That development would be mildly positive for equities.
For now, we remain selective on adding risk in the near term, despite recently more modest equity valuations.
- Consumer Price Index for All Urban Consumers (CPI-U): U. S. city average, by expenditure category
- Sam Stovall CFRA Research Chief Investment Strategist in a 3/16/2022 email