Markets Rally in Response to Latest Fed Rate Hike; Is It Too Soon?
The Fed raised the federal funds rate by 75 basis points to a target range of 2.25% to 2.5% at its late-July meeting in its continuing effort to tame runaway inflation. The move follows the Fed’s 75-basis-point increase in June, meeting what were strongly signaled expectations for both months.
Equity markets rallied in response to the news and Fed Chairman Jerome Powell’s hint that future rate hikes, although fairly certain, could be smaller. Some investors took this to mean that the Fed could begin lowering rates in 2023.
Kiran Kini, CoBank senior vice president and treasurer, isn’t so sure.
“Back-to-back increases of 75 basis points—or 1.5% over two months—amount to a very significant rate hike,” said Kini. “The rally in response to the hike indicates that the markets are resetting expectations for where the fed funds rate is going to end up and starting to price in rate cuts as early as next year.
“But I think it's a little premature to expect the fed to start to change direction and cut rates, or the market to price in cuts, in 2023,” he continued. “It is likely that the Fed will eventually slow down their rate hikes, but inflation is still very high and has come down just slightly. There are some signs that inflation is easing, but it’s going to take time to get down to the Fed’s 2% target.”
Indeed, the most recent statistics indicate that inflation is at a 40-year high. The Personal Consumption Expenditures Price Index for June, which was released on July 29th and is watched closely by the Fed, jumped 6.8% over 2021, its largest increase since 1982. July’s Consumer Price Index was 8.5%, down from 9.1% in June, also a 40-year high.
Kini indicated the Fed’s rate increases may be achieving their desired effect of slowing economic growth, which would begin to reduce inflation.
“We also have back-to-back quarters of negative GDP growth, which is fueling debate about the potential for a recession—is it a recession or is it not?” Kini said. “I don't want to get into that debate. At the end of the day, real growth is slowing down and the reason for that is inflation.
“Consumers are still generally in good shape. There is a decent amount of consumer spending, but we're paying more for everything. Inflation is eating into our purchasing power,” Kini continued.
Kini also noted that unemployment remains very low. To the surprise of many economists, 528,000 non-farm jobs were added in July, reducing the unemployment rate to 3.5%, its lowest level in 50 years. Still, several tech companies have announced layoffs recently, and the labor market could begin to turn. And wages continue to grow, although not at the same pace as inflation.
“Time will tell if we are in a recession,” Kini concluded. “If so, it is not at all your typical recession.”
