The Fed may raise 0.25% one last time this year
The Federal Reserve is convening once again to discuss interest rates over the next two days. Based on my analysis, I predict that there will be a 0.25% increase, marking the final hike for the year.
Here's why.
The first consideration is the impact that rate hikes have already had on the banking system. Banks have been hit hard by mark-to-market losses on their treasury bill holdings, as rising interest rates have pushed bond prices in the opposite direction.
Several banks, including Silvergate Bank, Silicon Valley Bank, Signature Bank, and most recently First Republic Bank, have already suffered significant losses as a result of the recent rate hikes. Clearly something has broke.
Given this situation, it seems unlikely that the Fed will adopt an aggressive stance on rate hikes in the near future. There are simply too many unknowns and potential risks associated with further hikes, and no one wants to take unnecessary chances with the stability of the financial system.
The second factor in the Fed's decision-making process is the inflation rate, which peaked at 9.1% in June 2022 before falling to 5% in March 2023. While inflation is still higher than the Fed's 2% target, the rate hikes have helped to moderate the impact of inflation significantly.
Given this situation, the Fed may have less reason to be aggressive with further rate hikes. With the inflation threat now contained and the target rate of 2% within reach, it is expected that the Fed will slow down its rate hikes accordingly. This will allow for a more measured approach that balances the need for continued inflation control with the need to support economic growth.
A third factor to consider in the upcoming Fed decision is the slower-than-expected growth of the US economy in the first quarter of the year. While forecasts had projected growth of 2%, the actual figure was only 1.1%.
One of the downsides of implementing aggressive rate hikes is that they can have a dampening effect on economic growth, as appears to be happening now. This effect may be delayed, which means that even if the Fed does not implement any further rate hikes, the US economy could continue to slow in the coming months.
Given these concerns, the Fed will need to proceed with caution to avoid pushing the economy into a recession.
Finally, it's worth noting that the Fed is already approaching the peak rate hikes based on its most recent Dot Plot. According to this projection, most committee members expect the peak interest rate for this year to be 5.1%.
Given that the current interest rate is already in the range of 4.75% to 5%, there is not much room left for further increases. A 0.25% hike would bring the interest rate in line with the peak expectations.
After this point, it is likely that the Fed will adopt a more cautious, wait-and-see approach. The committee will want to carefully monitor the effects of the rate hikes that have been implemented thus far, particularly given the potential for delayed effects on the economy.
Based on these factors, I anticipate that the Fed will implement only one rate hike of 0.25% at this meeting, and then maintain that level for the rest of the year.
Since the stock markets are forward-looking, it's likely that investors have already taken into account the possibility of a 0.25% rate hike from the Fed.
This is particularly evident in the performance of the Nasdaq Composite, which has a heavy weighting in tech stocks and has been hit the hardest by interest rate hikes. With the expectation of rate hikes coming to an end, the Nasdaq has rallied 18% year-to-date, outperforming the S&P 500, which has gained 9% over the same period.
However, given that the market has already factored in a 0.25% rate hike, it's unlikely that we'll see a major rally in response to this decision. Nevertheless, I am optimistic about the performance of the US stock market for the remainder of the year, as the stable interest rate expectation will likely provide a supportive environment for stocks.
Here's why.
The first consideration is the impact that rate hikes have already had on the banking system. Banks have been hit hard by mark-to-market losses on their treasury bill holdings, as rising interest rates have pushed bond prices in the opposite direction.
Several banks, including Silvergate Bank, Silicon Valley Bank, Signature Bank, and most recently First Republic Bank, have already suffered significant losses as a result of the recent rate hikes. Clearly something has broke.
Given this situation, it seems unlikely that the Fed will adopt an aggressive stance on rate hikes in the near future. There are simply too many unknowns and potential risks associated with further hikes, and no one wants to take unnecessary chances with the stability of the financial system.
The second factor in the Fed's decision-making process is the inflation rate, which peaked at 9.1% in June 2022 before falling to 5% in March 2023. While inflation is still higher than the Fed's 2% target, the rate hikes have helped to moderate the impact of inflation significantly.
Given this situation, the Fed may have less reason to be aggressive with further rate hikes. With the inflation threat now contained and the target rate of 2% within reach, it is expected that the Fed will slow down its rate hikes accordingly. This will allow for a more measured approach that balances the need for continued inflation control with the need to support economic growth.
A third factor to consider in the upcoming Fed decision is the slower-than-expected growth of the US economy in the first quarter of the year. While forecasts had projected growth of 2%, the actual figure was only 1.1%.
One of the downsides of implementing aggressive rate hikes is that they can have a dampening effect on economic growth, as appears to be happening now. This effect may be delayed, which means that even if the Fed does not implement any further rate hikes, the US economy could continue to slow in the coming months.
Given these concerns, the Fed will need to proceed with caution to avoid pushing the economy into a recession.
Finally, it's worth noting that the Fed is already approaching the peak rate hikes based on its most recent Dot Plot. According to this projection, most committee members expect the peak interest rate for this year to be 5.1%.
Given that the current interest rate is already in the range of 4.75% to 5%, there is not much room left for further increases. A 0.25% hike would bring the interest rate in line with the peak expectations.
After this point, it is likely that the Fed will adopt a more cautious, wait-and-see approach. The committee will want to carefully monitor the effects of the rate hikes that have been implemented thus far, particularly given the potential for delayed effects on the economy.
Based on these factors, I anticipate that the Fed will implement only one rate hike of 0.25% at this meeting, and then maintain that level for the rest of the year.
Since the stock markets are forward-looking, it's likely that investors have already taken into account the possibility of a 0.25% rate hike from the Fed.
This is particularly evident in the performance of the Nasdaq Composite, which has a heavy weighting in tech stocks and has been hit the hardest by interest rate hikes. With the expectation of rate hikes coming to an end, the Nasdaq has rallied 18% year-to-date, outperforming the S&P 500, which has gained 9% over the same period.
However, given that the market has already factored in a 0.25% rate hike, it's unlikely that we'll see a major rally in response to this decision. Nevertheless, I am optimistic about the performance of the US stock market for the remainder of the year, as the stable interest rate expectation will likely provide a supportive environment for stocks.
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