Fed Hikes Rates Another 0.75%, Citing Inflation

Given the growing evidence that economic growth is slowing, we expect the pace and magnitude of Fed rate hikes to slow going forward. The next FOMC meeting ... 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Explorewaystoinvest> Learn InvestingInsights Overview Overview Stocks Bonds ETFs MutualFunds Trading Options Futures Perspectives Overview MarketCommentary GovernmentPolicy Sectors International Retirement Overview SavingforRetirement InRetirement TheBasics Overview HowtoInvest Overview InvestingBasics InvestingGuide InvestingPrinciples Media Overview Podcasts Magazine SchwabLiveDaily OpenanAccount LogIn FindaBranch ContactUs LogIn MarketsAndEconomy FedHikesRatesAnother0.75%,CitingInflation July27,2022 KathyJones Asexpected,theFederalReserveraiseditstargetrangeforthefederalfundsrateby75basispointsto2.25%to2.5%,citinghighinflationasitsprimaryconcern. Asexpected,theFederalReserveraiseditstargetrangeforthefederalfundsrateby75basispointsto2.25%to2.5%,citinghighinflationasitsprimaryconcern.TheincreasebringsthefedfundsratetotheFed’sestimateofthe"neutralrate"—onethatitestimatestobelowenoughtoaccommodateagrowingeconomybuthighenoughtolimitinflationtoaround2%.Asinflationisrunningfarabove2%,theFedisindicatingitwilllikelykeephikingratesdespitewidespreadsignsofslowingeconomicgrowth. TheFedisalsocontinuingits"quantitativetightening"(QT)program—reducingthesizeofitsbalancesheetbylettingbondsitholdsmaturewithoutreinvestment.ThepaceofQTwillbegintopickupinSeptemberastheFedallowsmorebondsto"rolloff"itsbalancesheet.  Outlookfortheeconomysoftens Whileacknowledgingthatspendingandproductionhavesoftened,andtheinflationaryimpactofrisingenergyandfoodpricesduetotheRussia-Ukrainewarisbeyonditsreach,theFed'sviewisthatjobgrowthisstill"robust"enoughtopreventinflationfromreceding.Consequently,itsfocusisonslowingthedemandsideoftheeconomy.Thebigquestionis:Howhighrateswillneedtogotorestorepricestability? Currently,themarketispricinginapeakinthefederalfundsrateofabout3.4%laterthisyearorinthefirstquarterofnextyear,andthenadeclinelaterinin2023. Marketsarepricinginapeakfedfundsrateof3.4% AlthoughtheFOMCstatementandtheSEPpointedtothepossibleavoidanceofarecession,wehavealessbenignviewandbelievethesoftlandingshipmayhavealreadysailed.Thetighteninginfinancialconditionscontinuestopointtoameaningfuleconomicslowdown;first-quarterrealGDPgrowthwasalreadynegative,andnowexpectationsforsecond-quartergrowthareatthezeroline.PowellreinforcedthattheFedis"nottryingtoinducearecession,"butitmaybeanecessaryingredientinthelowerinflationrecipe. Source:Bloomberg,asof7/27/2022. MarketestimateofthefederalfundsusingFedFundsFuturesImpliedRate(FFM2COMBComdty).Forillustrativepurposesonly.PleasereadtheRiskDisclosureforFuturesandOptionspriortotradingfuturesproducts.FuturesaccountsarenotprotectedbySIPC.  TheFed'srecentestimatesareslightlyhigher.FederalOpenMarketCommittee(FOMC)participantssubmitquarterlyprojectionsabouttheeconomyandthepathofthefederalfundsrate;themedianprojectionforthefedfundsratein2022and2023was3.4%and3.8%,respectively,attheJunemeeting.Thissuggeststhatthecommitteebelievesitmayneedtohikeratesbyroughly100basispoints(orafullpercentagepoint)abovethat"neutralrate"torestorepricestability. FedChairJeromePowellhasindicatedthatthecommitteewouldliketoseeasustainedperiodoflowermonthlyinflationreadingsbeforeeasinguponitspolicytightening. Pathforward TheFedislikelytocontinuetalkingtoughonfightinginflationtopreventinflationexpectationsfromrising.Webelievethemessageisthatitiswillingtorisktriggeringarecessioninordertorestorepricestability.Althougharecessionisn'tthegoal,theFedmayalreadyhavetightenedenoughforonetodevelop.Grossdomesticproduct(GDP)growthinthefirsthalfoftheyearwasflatormaybeevennegative,financialconditionshavetightenedsignificantly,leadingindicatorshavedeclinedforfourconsecutivemonths,andtheyieldcurveisinverting—allsignsthatarecessionmaybelooming. The2-year/10-yearyieldcurveisnowinverted Source:Bloomberg.Dailydataasof7/27/2022. Note:TheratesarecomprisedofMarketMatrixU.S.Genericspreadrates(USYC2Y10).ThisspreadisacalculatedBloombergyieldspreadthatreplicatesellingthecurrent2-yearU.S.TreasuryNoteandbuyingthecurrent10-yearU.S.TreasuryNote,thenfactoringthedifferencesby100. Moreover,inflationexpectationsforthenextfiveto10yearshavebeenfallingsincetheonsetoftheFed'stighteningcycleandarenowhoveringinthe2.5%region. Breakeveninflationratesareofftheirrecenthighs Source:Bloomberg. U.S.Breakeven10Year(USGGBE10Index)andU.S.Breakeven5Year(USGGBE05Index).Dailydataasof7/27/2022. AbreakevenrateisthedifferencebetweentheyieldofaTIPSandtheyieldofatraditionalTreasurywithacomparablematurity.ThatdifferenceiswhatinflationwouldneedtoaverageoverthelifeoftheTIPSfortheittooutperformthetraditionalTreasury.Pastperformanceisnoguaranteeoffutureresults. Giventhegrowingevidencethateconomicgrowthisslowing,weexpectthepaceandmagnitudeofFedratehikestoslowgoingforward.ThenextFOMCmeetingisinSeptember–alonger-than-usualstretch.Betweennowandthen,themostimportantindicatorstowatchwillbethetwoCPIandPCEreports,alongwithconsumerspendingandjobgrowth.Ourbestguessatthistimeisthatthenextratehikewillbe50bps. Marketoutlook AslongastheFedmaintainsitsinflation-fightingstance,themajortrendinthefixedincomemarketislikelyfurtherinversionoftheyieldcurve.TheTreasuryyieldcurveisalreadyinvertedformaturitiesof2yearsthrough10years. Theyieldcurveisinvertedformaturitiesof2yearsthrough10years Source:Bloomberg,dataasof7/27/2022asof3:24PMEST. Pastperformanceisnoguaranteeoffutureresults. Summingitup Thereisariskthatbondyieldsrisefromheresincetheyhavefallensofastlately—anothermovetothe3%to3.25%rangeforthe10-yearTreasuryyieldcan'tberuledout.Longer-term,weexpectanyriseinyieldstobelimitedgivenexpectationsforapeakFedfundsrateofjust3.4%. Wesuggestinvestorsconsideraddingsomeduration—exposuretointerestraterisk—totheirportfoliosratherthanwaitingfortheFedtokeephikingrates.Bondladderscanbeaneffectivewaytoinvesttoday.Additionally,wedofavoranup-in-qualitybiasgiventheeconomicgrowthconcerns,focusingonTreasuriesandinvestmentgrademunicipalandcorporatebonds.We'remorecautiousontheriskierpartsofthemarket,likehigh-yieldbondsandemergingmarketdebt,astighterfinancialconditionsandslowergrowthcouldpulltheirpriceslower. GetSchwab'sviewonmarketsandeconomy. Seeallcommentary MorefromCharlesSchwab Trading WeeklyTrader'sOutlook It'sallaboutinflationandtheFed. MarketsandEconomy SchwabMarketUpdate:StocksDroppedAfterCommentsfromPowell U.S.stocksfinishedsharplylower,markingthesecond-straightweeklyloss. Futures LookingtotheFutures:NaturalGasRetreatsfromRecordHighs TheUSisstockinguponNaturalGasaseasingexportsandunexpectedweatherforecastpushonfuturesprices. Relatedtopics MarketsAndEconomy GovernmentPolicy Us