There are many experts coming out with estimations before the June Fed meeting. We would like to provide some context and perspective about what the Fed is considering.
In economics and investments, most of our education involves looking at past events so we can learn from them, especially to help avoid making the same mistakes in the future. But unfortunately, we are in uncharted territory. This environment is like no other. And while looking at prior Fed activity is instructional, the Fed never convened following a global pandemic or while the US supported a state in Europe at war with Russia. Today is unique and so must be the Fed’s response, building a potential path forward with the world as it is today, and not as it was.
The Fed funds rate (the rate member banks of the Fed charge to each other) is 1%, and the Fed is using this rate to try to get inflation under control. Inflation is commonly measured by Personal Consumption Expenditures (PCE) which is currently 8.6% and the Consumer Price Index (CPI) ex food and energy, which is currently 4.5%.
Economic theory says that raising the Fed funds rate higher than “inflation” is the surest method for getting inflation under control. But that would require the Fed to push interest rates over 8%, which is almost ridiculous considering the Fed is unlikely to push rates to even 4%. We have had an unusual period where inflation has not been a factor for over 20 years. And the Fed has been good at stimulating the economy during this period, but now they need to learn a new trick … unstimulating the economy without pushing it to recession.
When the Fed meets for two days, it can feel like the Cardinals are gathering to pick a Pope. We wait for smoke signals as if they are going to tell us what’s “really” happening. But the Fed comprises government employees who have a responsibility to control inflation while ensuring maximum employment. They don’t have a mandate for maintaining stock market values.
The Fed is scheduled to raise rates 0.5% in June and 0.5% in July, followed by another 0.25% in September and 0.25% in October. Most analysts expect the Fed to raise rates by 1.5% in total before the end of the year. With current rates at 1%, that would bring us to 2.5%. The market is reacting accordingly, fearful of the unknown, wondering if the Fed might have to raise rates more than expected.
Because the Fed has been slow to acknowledge inflation (for nine months, the Fed has called the price increases “transitory”), they are now sensitive to being late to the party. At 8.6%, inflation measured by PCE was still too high despite the actions the Fed has already taken. And the volatility we have experienced in the stock market comes as investors wonder if the Fed pushing rates to 2.5% will be enough, or if they might have to go as high as 4.5%. Extra increases are what economists, investors and some Fed members have talked about, but few people have been listening. And while these changes in Fed policy are significant, they are not life changing.
We are sharing these details so an increase in interest rates of 0.75% in June or July, or more increases in the fall, won’t trouble you, should they occur. Certainly, those buying a house or car will pay more in a higher rate environment. And borrowing, which has been uncharacteristically low for a long time, has changed; the days of “free money” are possibly ending. The Fed will continue to raise rates until they get the desired effect, but some investors are fearful of these changes. These changes in response to inflation and a tough economy have also made for a rough market. But as Walt Disney so eloquently put it, “After the rain, the sun will reappear. There is life. After the pain, the joy will still be here.”
The future is uncertain. We can search for answers as the problems become clear. The volatility of markets will always be present at different levels, with uncertainty being one catalyst. And it’s important to understand a situation from a historical perspective, but we also must realize that our markets will probably look different in the future. Information travels much faster now and investors’ reactions to changes also affect investments and markets at lightning speed. But these are immediate reactions, emotionally charged and often overblown. For a long-term investor, volatile market swings are tough to watch, but they are not of much consequence over time. And our investments—companies chosen because they represent the very best combinations of quality, value and opportunity—are the best way forward in uncertain times such as these.