On Wednesday, March 22, 2023, the Federal Reserve implemented a quarter percentage point interest rate increase. This recent rise is a smaller increase in rate hikes than has been recently seen, indicating to some that inflation has almost reached its peak. Furthermore, the Federal Open Market Committee, which sets interest rates, stated that future rises are not certain and will mainly rely on incoming data. With the emergence of this latest news, you may be left wondering, what’s next? This is truly a hard question to answer, and we can never predict the financial future with absolute accuracy. However, we may be able to rely on historical data to give us some kind of insight. Let’s take a look.
The first series of unprecedented policy rate changes began among global central banks in response to the economic impact of the 2020 worldwide pandemic lockdowns. The current rate-hike cycle started in full force in 2021. Early in 2022, when the number of central banks raising rates started to increase, stocks started to decline globally and entered a bear market. Currently, there have been more central banks raising interest rates than there were in 2008, when they were trying to control the huge liquidity that was supporting the global housing bubble. However, there are now hints that the rate rise trend may be peaking, which might be good news for investors.
The market now anticipates the major central banks, such as the U.S. Federal Reserve (Fed), European Central Bank (ECB), and Bank of England (BoE), may end their rate hikes in the first half of this year in light of the signs of an end to rate hikes among those central banks that led the movement and the most recent sentiment from the Federal Reserve and Federal Open Market Committee. If this is the case, what happens after?
To begin understanding what might happen if the fed stops raising rates, lets start with the basics. Given its fundamental objective, The Federal Reserve (the Fed) is concerned with anything that jeopardizes the functionality of the American economy. The Federal Reserve will increase interest rates (the target rate) to control inflation if it seems to be out of control, and will cut rates to encourage economic growth if the economy is in a slump.
The interest rates that depository institutions (like banks) charge one another for overnight loans are influenced by the target rate. These loans are frequently the last choice for banks to meet the Fed's liquidity standards.
The effective target rate is the average of all real overnight loans, with the actual Fed Funds rate serving as the reference. This rate is significant because it influences loans and other market rates. The Fed may directly affect interest rates across the U.S. economy and indirectly affect interest rates across the world by determining the target rate.
Now that we understand this, let’s take a look at how an end to rate hikes has historically affected an asset class like, say, the stock market. Currently, the market anticipates that after the rate high, policy rates will gradually drop starting in the second half of 2023. However, looking back, policy rate decreases haven't often been gradual. In actuality, throughout the past 20 years, the switch from increases to reductions has frequently been sudden and in reaction to economic downturns. For example, since 1970, the S&P 500 Index in the United States has achieved increases in 8 out of the 11 one-year periods that have followed each high in the federal funds rate, on average, following each of the Fed's most recent rate rises. Furthermore, the MSCI United Kingdom Index in the United Kingdom increased after each of the most recent rate rises by an average 9.4% during the subsequent 12 months, recording advances in 7 of the 11 one-year periods that followed each high in the bank rate.
Of course, there is no assurance that the market or central bank officials are accurate in anticipating the first half of 2023 as the final period of rate increases. Furthermore, when rate hikes do come to a halt, there is no assurance that markets will behave similarly to past trends. Despite the fact that none of these things can be predicted with complete accuracy, this knowledge may be favorable to investors looking ahead this year.
Start Planning For What’s Next
Instead of predicting what may or may not happen with the markets in 2023, it's time to consider your specific goals. The best way to plan for everything you hope to achieve is to develop, implement, and monitor a strategy designed to address your individual situation. Here at Fourth Avenue Financial, that is exactly what we do. So, if you are ready to start working towards a secure financial future, we are here to help. Contact us today at (304) 746 7977 to schedule a meeting with one of our experienced financial advisors or schedule online: https://calendly.com/fourthavenuefinancial/introductory-zoom.
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