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February 9th, 2023

Is Scaled-Down Rate Hike a Good Sign For the Markets?

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Katelyn Malcolm E. from Paterson, NJ asks: Hi Mitch, Curious to hear your thoughts about the Federal Reserve lowering its latest rate hike to 0.25%. Do you think it’s a good sign that rate hikes are coming to an end, and that maybe a market recovery will follow? Thanks for your time.

Mitchs Response:

Thanks for your email. The Federal Reserve has indeed scaled down the size of its interest rate increases, shifting from a 75 basis point hike in November to a 50 basis point increase in December to the now 25 basis point pace set in January. The past year has seen one of the steepest paths for fed funds, with the rate moving from the zero bound to between 4.5% and 4.75% as seen below1:

Federal Funds Effective Rate

Source: Federal Reserve Bank of St. Louis2

What Does Rate Hike Changes Mean for Your Investments?

To help you protect your investments during times of uncertainty, I recommend reading our new guide that puts the current environment in the context of the past 70 years. You’ll get insight on:

If you have $500,000 or more to invest, download our free guide, The Federal Reserve is Raising Rates. What Does This Mean for Stocks? 3, today.

I agree with your statement that the smaller size of rate increases is a good sign the Fed will pause rate hikes, likely in the spring or early summer. But your question concerning a potential market recovery to follow a Fed pause needs some clarifying. Mainly because the stock market (as measured by the S&P 500) is already up approximately +15% from the October lows – a rally that has accompanied the last three rate hikes.

Now, to be fair, it is always possible that the market could give back those gains and ultimately deem recent strength as a bear market rally. But it’s also true that if these recent gains were largely sustained and early October proved to be the beginning of the new bull market, it would be consistent with the market’s historical tendency of rallying before the peak in the interest rate cycle and before a trough in earnings, which we think will be reached in the first half of 2023. The stock market is forward looking, pricing-in economic and earnings conditions it sees 12+ months from now, not what’s on the ground today.

For its part, the Federal Reserve made no change to its projections for the fed-funds rate, restating the current target of between 5% and 5.25% for 2023 – with no rate cuts. In Chairman Powell’s words, “we’re talking about a couple of more rate hikes to get to that level we think is appropriately restrictive.” The Fed is intentionally leaving the door open to keep pushing if need be, which is something investors should keep an eye on.

A negative surprise of one or two more rate hikes than the market is anticipating would be bad news, in my view, as it will reset interest rate expectations higher which accordingly must reset the value of forward earnings lower. The outlook on this factor is mixed – the labor market continues to make the Fed’s job harder, while data in consumer spending and manufacturing is signaling a slowing economy that would allow the Fed to stick to its current path.

So, what can investors expect in the months ahead? There isn’t an exact answer, but to help you protect your investments against rising interest rates, I recommend reading our new guide that covers the history of the Fed4 raising rates to better help you with your financial planning going forward. You’ll get insight on:

Disclosure

1 Wall Street Journal. February 1, 2023. https://www.wsj.com/articles/fed-approves-quarter-point-rate-hike-signals-more-increases-likely-11675278190?mod=economy_more_pos8

2 Fred Economic Data. February 3, 2023. https://fred.stlouisfed.org/series/DFF#

3 ZIM may amend or rescind the guide “The Federal Reserve is Raising Rates. What Does This Mean for Stocks” for any reason and at ZIM’s discretion.
4 ZIM may amend or rescind the guide “The Federal Reserve is Raising Rates. What Does This Mean for Stocks” for any reason and at ZIM’s discretion.
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