The Aftermath

What is the Aftermath at the Conclusion of a Federal Reserve Interest Rate Hike Campaign?

The economy is experiencing the highest federal funds rate in more than a decade. The Fed hiked interest rates by a quarter point in March 2022 for the first time since 2018. In just over a years time, the Federal Reserve has increased interest rates 20x.

Source: Federal Reserve Board of Governors

Although inflation remains above the central banks target level of 2%. the economy is currently experiencing disinflation which is an indication that if current trends continue we may be near the conclusion of the current rate hike campaign. 

The Federal Reserve has announced that their goal is not only to defeat inflation and have it's annualized rate return back to a target of 2%, but in doing so they would like to keep the Federal Funds rate "higher, for longer." That could happen but the more likely scenario is that, given their propensity to make policy through the rear view mirror, it is reasonable to expect the Federal Reserve to miss whatever may be directly in front of them. In other words, they will continue to tighten until something breaks. And not if, but when that happens the tightening or rate increases end.

What happens then? As with all things, history lends us a clue.

In the past 40 years there have been six rate hike campaigns coordinated by the Central Bank. Some cycles were longer than others and some included more hikes than others. As an example, the cycle that ended in February 1989 began 11 months earlier and included 10 rate increases. The rate increase cycle that ended in June 2006 began 24 months earlier and included 17 rate increases. Of the six cycles since 1983, they have averaged 18 months in length and included a total of 9 interest rate increases. (See chart below)

The current cycle that began in March 2022 has (so far) lasted 12 months and included 9 interest rate increases. The question we want to know the answer to is what happened at the conclusion of prior Federal Reserve rate hiking cycles?

On average, the Fed Funds rate declined 139 basis points over the next twelve months. The rate on the 2 and 10 year treasury note declined 1.90% and 1.31%, respectively. Additionally, the dollar index strengthened and the S&P 500 averaged a return of 17.6%.

Also worth noting, the S&P 500 was positive for 5 of the 6 years following the conclusion of the Fed's rate hike campaign.

It seems likely that when the Federal Reserve meets on May 2-3, 2022 that there will likely be at least one more rate hike. If that is the final rate hike, it would tie for the 3rd longest rate hike campaign since 1983 and at 10 hikes, will be the third most in a campaign since 1988.

Although the "all items" basket of inflation increased 5% for the 12 months ending March 2023, this was the smallest increase since May 2021. Inflation appears to be on the decline. If the trend continues, the rate of inflation could reach the Fed's target of 2% within 3 quarters. 

What is the take away?

We may be close to the conclusion of the current rate increase campaign and if history is any reliable indication of what comes next, staying sensibly invested should benefit your portfolio.

One final note: While you wait to reap the historical benefits of what comes after a final rate increase, there are the benefits to be had from higher interest rates today. Specifically, if you have a stash of cash sitting in the bank - especially some of the large, national banks (Chase, Citi, Wells Fargo, Bank of America) you are almost certainly missing out on higher interest rates as these banks continue to pay well below market rate on their deposit accounts.

Currently, I am using a Schwab Value Advantage Money Market Fund for client accounts with large sums of uninvested cash. This money market fund offers a current yield of 4.66% and pays interest monthly. For money that investors want to commit to a longer window of time, I have FDIC insured CD's available that yield 4.50 - 5.00% for 12-18 months. Call or email me to discuss whether these options fit your plan.  

Source: U.S. Treasury Department TIC, FactSet, J.P. Morgan Asset Management. Data reflects most recently available information published by the U.S. Treasury in April 2022 for the period ending June 2021. Percentage of U.S. treasuries owned by foreigners is based on long-term marketable securities less bills outstanding and are as of 6/30 for each year. Caribbean Banking Centers include Bahamas, Bermuda, Cayman Islands, Curacao, Panama and St. Marteen. Oil countries include Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, Algeria, Gabon, Libya and Nigeria. Data on this page are updated quarterly to reflect revisions by the Treasury.

Guide to the Markets – U.S. Data are as of March 31, 2023.