May 4, 2022
Fed delivers a 50-basis-point (bp) hike and begins quantitative tightening
Despite a reign of 25-bp moves over the last 20 years of monetary policy, the Federal Reserve today raised the Fed Funds Target Rate by 50 bps; this is the first 50-bp change since May 2001.
Given the strong inflation numbers, markets had feared more aggressive actions by the Fed. Importantly, Chairman Powell indicated a 75-bp hike is not for current consideration.
The markets responded extremely positively to the news that rate hikes would likely follow a consistent path — stocks closed up more than 2.8%, which is the largest daily increase since May 2020.
The accompanying statement indicated a strong economy that could withstand higher rates as job gains have been robust, and there remain more jobs open than job seekers can fill.
However, the economic impacts of the Ukraine invasion and the COVID-related lockdowns in China are creating upward pressure on inflation and are likely weighing on economic activity in the U.S.
- Fixed income markets anticipated today’s moves by the Fed. U.S. Treasury yields were flat to lower by 2-3 bps following the announcement. The 10 Year U.S. Government bond closed at a yield of 2.93%. Credit spreads remained stable on the heels of a continued strong economy and the Fed’s messaging that it will maintain a measured approach to raising rates.
- Following today’s Fed actions, the yield curve largely remains positively sloped — an important indicator for recessions. We don’t see the odds of a recession in the U.S. increasing after today’s action. We are still at 25%.
- Equities continue to digest the 1-2 punch of higher rates and quantitative tightening (when the Fed sells bonds from its portfolio). The Fed began the process late in 2021 on the back of surprising economic strength.
- While the stock market is down approximately 10% year-to-date, fundamentals like margins and cash flows remain strong. We continue to expect corporate profits to grow in 2022 and contribute to positive total return for the remainder of the year.
- We expect the Fed to remain focused on slowing inflation and will continue to raise rates until inflation falls and the mismatch in the job market closes. With inflation still strong, we think the Fed will raise rates by 50 bps at the June meeting and continue this pattern until summer when we expect inflation to turn lower. This pattern of financial tightening will limit any valuation expansion in equity markets.
- Volatility will persist across stock and bond markets until there is greater clarity on the path of inflation (we think it will be lower by the end of 2022), the Russian invasion of Ukraine, and China’s stop/start COVID policy, which is affecting global supply chains.
- We think portfolios should be near long-term strategic allocations as we look for opportunities to diversify income sources and add quality equities at lower prices, and would benefit from adding to alternative assets.
First Republic Private Wealth Management encompasses First Republic Investment Management, Inc., an SEC-registered Investment Advisor, First Republic Securities Company, LLC, Member FINRA/SIPC, First Republic Trust Company (“FRTC”), First Republic Trust Company of Delaware LLC (“FRTC-DE”) and First Republic Trust Company of Wyoming LLC (“FRTC-WY”).
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