What Did the Fed Do?
Last Wednesday, March 16, 2022, the Federal Reserve increased the federal funds rate 0.25%. Even though the market expected this increase (Fed Chairman Powell all but announced the 25bps rate hike previously), the stock market fell approximately 1.5% in the 30 minutes after the official announcement.
During the subsequent Q&A session that same day, Chairman Powell stated he was confident that the current economic growth and employment outlook would be able to handle future rate increases. This commentary sparked a rally in the stock market which saw the S&P 500 index rise in excess of 6% from the time of the rate increase announcement to us writing this note (the growth stock laden Nasdaq index rallied more than 8%).
While there are many factors that move stocks, we have cited Fed policy as being a significant driver (and we are not 100% in agreement with the Fed outlook thus still expect future stock market volatility). In fact, on Monday, March 21, 2022, Chairman Powell suggested he would not be opposed to a 50bps hike at the next Fed meeting, which promptly caused a 1% intra-day decline in the broad stock market indices. Volatility indeed
What Does the Rate Increase Mean?
What exactly does an increase in the “federal funds rate” mean? The federal funds rate is the interest rate banks charge each other to borrow and lend excess reserves overnight. The federal funds rate also influences the prime interest rate. This is important because the prime rate influences the interest rate on financial products such as credit cards and personal & auto loans.
What has typically occurred during the 24 months after the Federal Reserve first raises the interest rate is that longer maturity Treasury yields, such as the 10Yr and 30Yr, historically rise less than shorter maturity yields (i.e., the 2Yr). There is a similar dynamic across lending rates as the 30Yr fixed rate mortgage, which has a longer maturity, historically increases less than the prime interest rate, which is typically a benchmark for shorter maturity loans. Why does this occur? The short-end of the Treasury yield curve is more sensitive to Federal Reserve policy, while the long-end of the yield curve is more sensitive to economic conditions.
These interest rate changes can impact your personal finances in several ways. As we have seen several times in the past week alone, changes in interest rates or, perhaps more importantly, expected changes in interest rates, can have a notable impact on your stock portfolio. Additionally, higher interest rates typically result in lower bond prices. Unexpected changes in the timing or magnitude of interest rate increases could have a negative impact on your balance sheet should stocks and bonds both produce negative returns. You may also find your borrowing costs rising should you have variable rate debt such as home equity loans or credit card debt.
Why is Fed Doing This?
The Fed is raising interest rates in an attempt to reduce inflation pressures. Last month, U.S. inflation reached a 40 year high at 7.9%. Higher interest rates will increase borrowing costs, which could in turn lead to decreased consumer demand. This reduction in demand should lead to lower prices. The risk remains that the Fed has misjudged the strength of the economy and future rate increases stall economic growth and trigger a recession. Add in the war in Ukraine, tensions with China, and mid-term elections in the U.S and the outlook becomes even more unknown. As such, we will do our best to keep you informed and help guide you through this, and future, periods of uncertainly.
Dennis P. Barba, Jr.
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the authors and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request. CAR-0322-03971