For the first time in four years the Fed raised rates this week. Central banks globally had responded to COVID-19 by loosening monetary policy to boost spending and maintain growth. But with inflation hitting 40-year highs recently and with unemployment rates back to pre-pandemic lows, the Fed started on their hiking cycle with a 25 basis-point move to bring the Fed Funds rate to 25-50bps. The FOMC also indicated in their SEP Forecast that would get the Fed Funds rate to 1.9% by the end of 2022 and 2.8% by the end of 2023 reaching a neutral rate of about 2.4% -- and that neutral rate is around one that does not either slow down or accelerate the economy.
It's not uncommon for hiking cycles to spook stocks. But as the path forward becomes more clear, most sectors in the S&P 500 index have mustered positive returns in the year that follows the first hike.
Stocks aren't the only things impacted by rising rates. Rising rates can mean higher costs to borrow, be that in higher mortgage rates, student loans or credit card interest charges. That does serve to slow down demand, and could result in declining inflation, at least in certain demand driven categories. How fast it falls will dictate how high interest rates ultimately need to go. Currently investors are forecasting 7 total rate hikes 2022, which is more than our estimates: fears about hurting growth will make the Fed more tolerant of inflation than they have been in the past; and we see fewer rate hikes than what the Fed is now indicating in their SEP forecasts.
What can we do to help guard against hiking risk in our Portfolios? We like taking a diversified approach to navigating the hiking cycle. In equities, this means choosing pockets of the market with strong pricing power and healthy profit margins and that should also to well as growth slows from the peak. That should also do well if inflation stays higher than it has been in the past. In the fixed income markets we like inflation-linked bonds and, more recently, front end credit. This should benefit from the lower path of policy rates, which is what we expect. Finally, in the commodity markets, we like to see investors holding a basket of diversified commodities.
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