The Federal Reserve has been raising its Federal Funds Rate consistently over the past year. At the start of 2022, the bottom level of their target range was 0.00%. They started raising rates in March with an 0.25% increase. At the time, the rhetoric was that inflation increases were transitory and that soon inflation would stabilize. Over the course of the next nine months, the rhetoric changed as inflation was proving stickier than originally anticipated. The result being a U.S. Federal Reserve that increased rates another six times and ended the year with interest rates higher by 4.25% than at the start of the year.
Why is the U.S. Fed Funds Rate important to Canadian investors?
By raising rates, a central bank strives to constrain economic growth and force the economy to slow, frequently resulting in a recession. Since the Canadian economy is so closely connected to the much larger U.S. economy, any significant changes down south will impact the Canadian economy as well and therefore the Bank of Canada’s strategy.
It is this potential of driving an economy into recession that has economists and investors concerned that the U.S Federal Reserve is raising rates too quickly. There is significant lag time between when the central banks raise interest rates and when the impact is felt in the economy, making monetary policy as much an art as a science.
As you can see from the chart, this series of rate hikes has moved rate much higher much faster than any other sequence of rate hikes in the past forty years. Expectations are that the Fed has targeted 5.0% as being the “terminal rate” at which point they will pause to see the effects of their handiwork.
So far, the seven rate hikes of last year have not yet caused a recession and although inflationary pressures are easing, the increases have not succeeded in bringing inflation down to the 2% target level. Thus, we can expect further rate hikes in 2023. There are realistic concerns that the Fed is not giving the existing rate hikes enough time to work through the economy and that the central bank may have already done enough.
Over the past two decades, financial markets have become increasingly tied to monetary policy decisions, and even a hint of a change in policy direction by the U.S. can impact financial markets. This is why market commentators will often tell you, “Don’t fight the Fed.”
Disclaimer: Please note that the publication is designed to provide general information only. It reflects the thoughts and opinions of Logan Wealth Management and should not be construed as financial advice, nor should the information be considered a substitute for personal advice. Information used in this publication has been gathered from sources believed to be reliable. Logan Wealth Management is not responsible for and assumes no liabilities or responsibility for any loss or damages suffered as a result of the use or misuse of, or reliance on the information or content of this publication. Please consult your financial adviser to determine whether the information is applicable to your personal situation.
