What the Fed’s largest rate hike since 1994 means for your investments

By Beansprout • 16 Jun 2022 • 0 min read

The US Federal Reserve (Fed) raised its benchmark interest rate by 0.75 percentage point - the largest rate hike since 1994.

What the Fed’s largest rate hike since 1994 means for your investments

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What happened?

The US Federal Reserve (Fed) raised its benchmark interest rate by 0.75 percentage point in June. This is the largest interest rate hike since 1994. 

Increase in Fed interest rate

This was largely expected by investors, who have raised their forecasts of how much the Fed will raise interest rates by over the past week.  

Earlier, a CME Fed Watch poll showed a 96% probability of a 0.75 percentage point rate hike. 

Apart from higher than reported inflation numbers, the change in expectation came through from a Wall Street Journal article earlier in the week that reported that the Fed was looking at a more aggressive rate hike. 

The lack of surprises in the interest rate announcement led to a relief rally in stocks. The S&P 500 rose 1.46% and the Nasdaq rose 2.50% at the market close on 16 June, following days of sharp declines. 

On the other hand, the US 10-year government bond yield fell by 0.14 percentage point to 3.34%. 

Two questions on everyone’s mind

Apart from the actual rate hike, investors were also looking out closely for what Fed Chairman Jerome Powell would say. 

This would give some hints about the pace of rate increase in the coming months. 

More importantly, the Fed had to show that it was “ahead of the curve” and able to control inflation.

#1 – Will there be more interest rate increases to come?

The stock market started to see a bounce after Powell said that the next decision in July would be between a 0.5 and 0.75 percentage point hike. 

More importantly, he also said that a 0.75 percentage point increase would not be too common after that.

Overall, the Fed expects the benchmark rate to be at 3.4% by the end of the year, compared to the current rate of 1.5-1.75%. 

#2 – Will we see a recession?

Given everyone’s concerns about a potential recession, Powell addressed this head on by saying that the Fed is not trying to induce a recession.

However, what it is focused on is to bring down inflation. 

Here, Powell was quick to admit that Fed officials have been expecting progress on inflation but have gotten quite the opposite. 

After all, the US consumer price index rose unexpectedly to 8.6% in May, marking the highest increase in 40 years. 

Powell added that “inflation can’t go down until it flattens out, and that’s what we’re looking to see.”

With inflation so sharply in focus, it is no wonder that more and more economists are now expecting a recession. 

“The Federal Reserve is going to hike interest rates until policymakers break inflation, but the risk is that they also break the economy,” wrote Ryan Sweet from Moody’s Analytics in a research note.

What would Beansprout do?

For now, the market seems to be relieved that we won’t see many of such 0.75 percentage point rate increases in the coming months.

However, we wouldn’t take this as a definitive sign that we have seen the market bottom.

Last month, when the Fed raised interest rates by 0.5 percentage points, the market also saw a relief rally before the bounce was reversed dramatically the next day. 

It is hence quite likely that the volatility will continue as investors digest the various messages that came out from the Fed meeting. 

Like it or not – whether you are holding on to a REIT or tech stock, what the Fed says and does in the coming months will affect how these investments will perform.

And one thing is almost certain – the Fed will be looking out closely for inflation numbers. And that is what we will be watching for as well.

If inflation refuses to come down, then we might see even more interest rate increases compared to what the market is forecasting now.

If you are feeling jittery about the market and are looking for a simple way to generate safe returns, do check out our recent writeup on the Singapore Savings Bonds.

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