The Federal Reserve voted to increase interest rates by 0.25% in its latest meeting, and while six more rate hikes are currently baked into the “dot plot,” or FOMC Summary of Economy Projections, some Fed officials are hinting at the potential of half point increases for two of those meetings. Mark Hackett, chief of investment research for Nationwide’s Investment Management Group, discusses concerns of the Fed being behind the curve on interest rate increases in a recent blog post on the Nationwide website.
Federal Chair Jerome Powell opted for a quarter point increase in this initial round of interest rate increases, taking a more cautious approach given the uncertainty that the Russia-Ukraine war has caused for markets. Some analysts have expressed concern that the Fed might be enacting interest rate increases late and that the quarter point increase wasn’t aggressive enough.
Now, concerns of aggressive tightening by way of higher increases coupled with Fed balance sheet reductions are reflected in the Fed futures curve, which is predicting this as a likely possibility.
“The Fed Funds futures curve embeds this scenario as likely; market participants currently give a 76% chance that the median of the dot plot is too low. The curve also embeds rate cuts in 2024, suggesting the Fed will make a policy error during this cycle and be forced to lower rates,” Hackett writes.
Image source: Nationwide Blog
In the past, the average unemployment rate was 6.3% and the average core CPI was 2.7% when the Fed would begin a cycle of rate increases; current numbers are 3.8% for unemployment and 6.5% for core CPI. Because these numbers are so far from the more historical benchmarks that brought on Fed tightening, they add to concerns of overly aggressive tightening as the Fed possibly works to reign in inflation more rapidly.
“This has meaningful implications for equity markets and raises the potential for a bear market. The S&P 500® Index experienced a correction earlier this year with a drawdown of 13%,” Hackett explains. “Corrections of 10% are not uncommon or unhealthy, as they occur once or twice a year on average, but a bear market (a decline of 20% from a recent peak) is rare without a recession.”
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