How might markets perform as the Federal Reserve hikes interest rates?
Positive corporate earnings, above-trend growth and still accommodative financial conditions suggests risk assets can still perform well as the Fed raises interest rates.
Global Market Strategist
For the first time since December 2018, the Federal Open Market Committee (FOMC) voted to raise the Federal funds target rate range by a ¼ percent to 0.25%-0.50% at its March meeting and made clear further increases would be appropriate to tame inflation. In addition, the committee plans to reduce the size of its now $9.0 trillion USD balance sheet “at a coming meeting”. We believe the committee will announce a path towards balance sheet runoff at its May meeting and commence rolling off its assets beginning mid-May or June.
With regards to the FOMC’s updated economic projections:
Effectively, committee members view the labor market as incredibly tight and for growth to still be robust, and therefore the primary focus will be too cool inflation to promote a long expansion. To achieve this, the median voting member now expects seven hikes this year and four hikes next year. Consequently, short rates could end this hiking cycle higher than the committee’s long-run projection or perceived neutral rate of 2.4%, a clear indication the committee’s base case is for persistent inflation that may not be quelled until rates are restrictive.
For investors, as the Federal Reserve (Fed) tightens policy, it may be useful to consider how markets behaved in past rate hiking cycles. As highlighted, since 1983, there have been six hiking cycles, lasting 18 months on average.
There are a few key takeaways:
We continue to believe the risk of a recession this year is minimal; however, a hawkish Fed does increase recession risks sometime in 2H23 or 2024. That said, positive corporate earnings, above-trend growth and still accommodative financial conditions suggests risk assets can still perform well as the Fed raises interest rates.
Historical impact of Fed tightening
Target rate*, shaded areas denote periods of rate hikes
Market reaction during previous rate hiking cycles