Fed Funds Rate Beginning to Stabilize. Morningstar - Rate Cuts On The Horizon

As we enter May of 2023 the stock market is up on the year, despite the banking crisis we've experienced in the last couple months. The failure of First Republic Bank, which was taken over by banking giant JP Morgan Chase, was no surprise as the bank had been on life support ever since the collapse of Silicon Valley Bank. Thus far, the stock market reaction to this most recent bank failure has been muted. As of this writing, the "bottom" of the stock market was in October of 2022. That was 6 months ago. In other words, the worst of this current market crisis may be in the rear view mirror. Time will tell. Here is what is happening now:

The labor market has been steady, with the U.S. unemployment rate currently at 3.5% (source: Bureau of Labor Statistics). Despite the headlines of tech company layoffs, the broad U.S. unemployment rate has remained constant since the beginning of 2022.

The rate of inflation has also been falling, with the Consumer Price Index (CPI) clocking in at 5%. Though this is above the Federal Reserve’s long term target rate of 2%, it’s below the peak rate of 9.1% we experienced in June of 2022 (source: Bureau of Labor Statistics). Of course, this doesn’t make a trip to the grocery store any better!

On the sunny side, the price of eggs unexpectedly fell in February and in March of 2023, a trend that is expected to continue (source: CNBC).

It is expected that the Fed will raise rates by 0.25% once, maybe twice, in the coming months and then pause for the rest of 2023. The Fed Funds rate is currently between 4.75-5% (source: Forbes). The Fed meets again on May 2nd, with a public statement relating to rate hikes on May 3rd. The market is predicting a 90% likelihood that the Fed raises rates by another 0.25% this week. This would bring the Fed Funds rate to a target range of 5-5.25%. No one expects a higher increase than 0.25% right now, considering the fragility in the banking sector. A small minority of traders believe that no rate hike will come at this meeting. Remember that the Fed Funds rate is the interest rate that banking institutions in the private sector charge each other on overnight loans. The rate itself is set by the US Federal Reserve. The Fed Funds rate indirectly influences many other types of loan rates, including mortgage rates.

It is believed by many that rates could start dropping again as early as the end of 2023. Major financial institutions such as Morningstar predict that the Fed Funds rate may be cut swiftly starting in 2024, reaching as low as 2% by the end of next year (source: Morningstar). We'll see. The Fed will tell you that any future rate cuts will be contingent on progress toward bringing the rate of inflation down. Note – the below chart is a forecast only, but serves to illustrate that interest rates are not expected to remain elevated indefinitely.

Why are we talking about interest rates? Because last year, when the Fed raised rates at the fastest pace in 40 years, it caused the stock market to decline precipitously. The 2022 pace of rate increases changed the rules of the game for all businesses, causing forward-looking earnings estimates to drop and company valuations (think: the stocks you own) to drop. Now that rates appear to be stabilizing, we are now in the very early stages of anticipating future rate cuts. Future rate cuts have the potential to increase future earnings as well as company valuations. Ultimately, when this occurs, your portfolio may also benefit. 

It's important to remember that investing in the stock market should be a long-term strategy. Short-term fluctuations in the market happen. Markets are cyclical. As far as market cycles go, the downturn we’ve come through has been especially long and deep already. If you use history as your guide, and you’re in a well-diversified portfolio, you can be confident that you are well-positioned for the future. If you’d like for us to take a deeper look at your portfolio – whether you invest with us or not – we would be happy to do so. Thank you for your continued trust.

Best regards,

The CameronDowning Team