Morningstar
RecommendedMorningstar AwardsWhats New IconETFs Whats New IconIncome Week Whats New IconThematic Investing Whats New IconSign Up to Our Newsletters Open Window Icon
Economic Insights

Federal Reserve's Largest Rate Rise Since 1994

Rise of 0.75 percentage points takes the federal funds rate to 1.5%, up from 0% at the start of the year 

Preston Caldwell 16 June, 2022 | 9:09AM
Facebook Twitter LinkedIn
Font-Size

Federal Reserve building

With its largest interest-rate increase in 28 years, the Federal Reserve signalled a stepped-up determination to fight inflation, even if it ultimately takes a toll on the economy.

The Fed announced Wednesday that it was lifting the federal funds rate by 0.75 percentage points, the largest interest-rate increase since 1994. This marks an aggressive policy shift, as the Fed previously signalled intentions to raise the rate by a smaller 0.50 percentage points.

With the latest hike, the federal funds rate rises to 1.5% (the bottom of the target range), up from 0% at the start of the year. Futures markets imply that the federal funds rate will hit 3.75% by the first quarter of 2023, in line with the Fed's official projections.

Fed has signalled a shift to a more hawkish stance, with its determination to bring inflation under control having become increasingly urgent. We think the market is correct in assessing this shift in the Fed's stance.

The two-year US Treasury yield has increased about 0.6% over the past two weeks, with the 10-year US Treasury up about 0.4%. This has added to a sharp rise in bond yields, which began late last year. Because anticipated increases in the federal funds rate are incorporated into bond yields, they are already starting to affect the economy.

With the 30-year mortgage rate now closing in on 6%, housing affordability has suffered immensely. This is bound to have a large negative impact on housing demand and (ultimately) building activity. We had already expected about a 10% drop in housing starts in 2023 prior to the uptick in rates in recent weeks, but now the downturn is likely to be even greater. A downturn in housing will be a major factor in slowing the overall rate of gross domestic product growth.

Federal Funds Rate Expectations

For now, we don't expect an outright recession, but with our base case incorporating a slower rate of GDP growth, the risk of a recession has become elevated. We project 2.2% real GDP growth in 2023, while the Fed is expecting 1.7%. While the Fed is hoping to avoid a recession as collateral damage in its fight against inflation, it appears comfortable with the risk.

Labour markets are getting closer to a full recovery. The unemployment rate is already essentially back to its pre-pandemic mark, while the overall rate of employment is not far behind as the rate of labour force participation has begun to recover. An economic slowdown would likely cause some temporary deterioration in the labour market, but the Fed's progress in achieving its full-employment mandate is running miles ahead of success in achieving its low-inflation mandate.

Fed chair Jerome Powell mentioned that near-term inflation data had disappointed compared with hopes that signs of progress would begin emerging. The Consumer Price Index increased 8.6% year over year in May. We argued that this stubbornly high inflation increased the likelihood of a 0.75% hike for the Fed meeting in June, which proved correct.

The Federal Reserve's effectiveness in stamping out high inflation depends on how quickly supply shocks — such as the hit to Russian oil supply and the global semiconductor shortage — can resolve. Additionally, if long-run inflation expectations increase and remain high, then actual inflation will remain high even as the Fed achieves a slight slowdown in economic growth. This scenario would require even more aggressive moves from the Fed to reverse the increase in inflation expectations.

 

TAGS

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Facebook Twitter LinkedIn
Font-Size

About Author

Preston Caldwell  is equity analyst at Morningstar.

 

© Copyright 2024 Morningstar, Inc. All rights reserved.

Terms of Use        Privacy Policy        Modern Slavery Statement        Cookie Settings        Disclosures

The Morningstar Star Rating for Stocks is assigned based on an analyst's estimate of a stocks fair value. It is projection/opinion and not a statement of fact. Morningstar assigns star ratings based on an analyst’s estimate of a stock's fair value. Four components drive the Star Rating: (1) our assessment of the firm’s economic moat, (2) our estimate of the stock’s fair value, (3) our uncertainty around that fair value estimate and (4) the current market price. This process culminates in a single-point star rating that is updated daily. A 5-star represents a belief that the stock is a good value at its current price; a 1-star stock isn't. If our base-case assumptions are true the market price will converge on our fair value estimate over time, generally within three years. Investments in securities are subject to market and other risks. Past performance of a security may or may not be sustained in future and is no indication of future performance. For detail information about the Morningstar Star Rating for Stocks, please visit here

Quantitative Fair Value Estimate represents Morningstar’s estimate of the per share dollar amount that a company’s equity is worth today. The Quantitative Fair Value Estimate is based on a statistical model derived from the Fair Value Estimate Morningstar’s equity analysts assign to companies which includes a financial forecast of the company. The Quantitative Fair Value Estimate is calculated daily. It is a projection/opinion and not a statement of fact. Investments in securities are subject to market and other risks. Past performance of a security may or may not be sustained in future and is no indication of future performance. For detail information about the Quantiative Fair Value Estimate, please visit here

The Morningstar Medalist Rating is the summary expression of Morningstar’s forward-looking analysis of investment strategies as offered via specific vehicles using a rating scale of Gold, Silver, Bronze, Neutral, and Negative. The Medalist Ratings indicate which investments Morningstar believes are likely to outperform a relevant index or peer group average on a risk-adjusted basis over time. Investment products are evaluated on three key pillars (People, Parent, and Process) which, when coupled with a fee assessment, forms the basis for Morningstar’s conviction in those products’ investment merits and determines the Medalist Rating they’re assigned. Pillar ratings take the form of Low, Below Average, Average, Above Average, and High. Pillars may be evaluated via an analyst’s qualitative assessment (either directly to a vehicle the analyst covers or indirectly when the pillar ratings of a covered vehicle are mapped to a related uncovered vehicle) or using algorithmic techniques. Vehicles are sorted by their expected performance into rating groups defined by their Morningstar Category and their active or passive status. When analysts directly cover a vehicle, they assign the three pillar ratings based on their qualitative assessment, subject to the oversight of the Analyst Rating Committee, and monitor and reevaluate them at least every 14 months. When the vehicles are covered either indirectly by analysts or by algorithm, the ratings are assigned monthly. For more detailed information about these ratings, including their methodology, please go to here

The Morningstar Medalist Ratings are not statements of fact, nor are they credit or risk ratings. The Morningstar Medalist Rating (i) should not be used as the sole basis in evaluating an investment product, (ii) involves unknown risks and uncertainties which may cause expectations not to occur or to differ significantly from what was expected, (iii) are not guaranteed to be based on complete or accurate assumptions or models when determined algorithmically, (iv) involve the risk that the return target will not be met due to such things as unforeseen changes in changes in management, technology, economic development, interest rate development, operating and/or material costs, competitive pressure, supervisory law, exchange rate, tax rates, exchange rate changes, and/or changes in political and social conditions, and (v) should not be considered an offer or solicitation to buy or sell the investment product. A change in the fundamental factors underlying the Morningstar Medalist Rating can mean that the rating is subsequently no longer accurate.

For information on the historical Morningstar Medalist Rating for any managed investment Morningstar covers, please contact your local Morningstar office.

For more detailed information about conflicts of interest, including EU MAR disclosures, please see the “Morningstar Medalist Rating Analyst Conflict of Interest & Other Disclosures for EMEA”here

Select Your Site Edition To make sure the site is relevant to you, we need to know if you’re an individual investor or a financial professional.