Last week the Federal Reserve increased the federal funds rate by 25 basis points (0.25%), with an additional 6 rate hikes expected in 2022. This is the first-rate increase by the Fed since 2018. We followed the market reaction as Federal Reserve chairman Jerome Powell first announced the rate hike last week. There was higher volatility and a market sell-off when the announcement started, but by the end of the meeting, markets had rallied with strong buying into the close. This strong buying continued throughout the rest of last week.
The bullish case going forward involves the Fed’s take on the lower likelihood of a recession in 2022. There are risks with geopolitical events in Ukraine, but overall the US economy is showing signs of strength. The Federal Reserve is walking a fine line of increasing rates to fight inflation but not increasing rates too fast which would cause too much of a slowdown in economic activity. We are encouraged by the Fed’s optimism about the strength of the US economy but remain cautious with supply chain issues and current inflationary pressures. This will continue to cause short to medium-term volatility, but we expect the long-term bullish story to continue.
The area to focus on when raising rates to combat inflationary pressures is the speed at which rates are increased. If rates are increased too fast, then the economy could go into a recession. If rates aren’t increased fast enough, then inflation could continue to remain elevated. It is worth noting the historical reaction to interest rate increases. History seems to tell us that if the Federal Reserve raises interest rates aggressively, recessions tend to follow (shaded gray areas).
Based on recent Federal Reserve communication and current inflation levels, the Federal Reserve will have to act more aggressively to combat inflation. We expect the Federal Reserve to hike the federal funds rate by 50 basis points for the next few meetings. The increased rates will be a headwind on economic growth but are necessary to combat elevated inflation levels.
If you have any questions, please reach out to us at info@nicholaswealth.com or (404) 890-5606.
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