Janet A. from Colorado Springs, CO asks: Hello Mitch, I noted in the news last week that the Federal Reserve was open to bigger interest rate increases, and it appeared that the statement spooked the markets. What are your thoughts on this?
Thank you for sending in your question. You’re referring to remarks made last week by Federal Reserve Chairman Jerome Powell at a discussion before the National Association of Business Economics, where he said that “if [the Fed] thinks it’s appropriate to raise [by a half point] at a meeting or meetings, we will do so,” adding that, “if [the Fed] determines that we need to tighten beyond common measures of neutral and into a more restrictive stance, we will do that as well.”1
These comments came just a few days following the Federal Reserve’s decision to raise the benchmark fed funds rate from near zero to a range between 0.25% and 0.50% – a modest quarter-point hike.
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What threw the market a bit was Mr. Powell’s seeming shift into a more hawkish tone, just days after the formal Fed decision. It was as though the market got a clearer glimpse into the Fed Chairman’s actual thinking, which revealed more hawkishness than previously thought.
I generally agree that a bigger- and more aggressive-than-expected path of rate increases would be a negative for stocks, as the market does not like surprises. But I’m encouraged by two features of this story, at least in the near term.
The first is that Chairman Powell is telegraphing his thoughts on interest rate policy and inflation, which reduces the likelihood of a negative surprise. The second feature is that we are just one rate hike into what is likely to be a multi-year monetary tightening campaign. As I’ve written in the space before, bull markets and economic expansions end after the Fed’s last rate hike, not their first one. Stocks have performed quite well historically in the early phases of rate hike cycles, and I expect a similar outcome for 2022 given the strong economic growth backdrop.
All that to say, I would not worry too much about Fed policy this year. The equity market is well aware of the Fed’s plans this year and much of the expected tightening for 2022 is already getting baked into stock prices, in my view. If you want a better interest rate metric/fundamental to watch this year that can give you some insight into the growth outlook, keep your eye on the yield curve as measured by the 10-year US Treasury bond yield minus the 3-month US Treasury bond yield. As you can see in the chart below, the yield curve has been steepening so far in 2022, a good sign that growth conditions are present even as the Fed engages in a tightening campaign.
More rate hikes are coming in 2022, but the good news is that market participants are all aware of it. I do not think you need to fear the Fed this year.
With that being said, in times like these, it is better to base your decisions on research, not emotions! Don’t sell and exit the market or wait on the sidelines out of fear.
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