To The Moon

The FOMC meeting concluded with the Fed approving the first rate hike of 2022 at +0.25%. They also indicated support for six additional rate hikes throughout the duration of 2021.

This month’s rate hike is the first increase to the federal funds rate since December 2018. Interest rates have stayed close to zero since the onset of the pandemic, but those rates will now see increases between 0.25-0.50%. The Fed hopes to reach a consensus rate of 1.9% at the end of 2022.

In addition to raising interest rates, the Fed anticipates reducing its $9 trillion balance sheet. JPow indicated that trimming the Fed’s fat balance sheet could begin in May, and it could act like an 8th rate hike. The FOMC shared:“[The Federal Reserve] anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee expects to begin reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities at a coming meeting.”

The committee also adjusted its inflation estimates for the year, with personal consumption spending (not including food/energy) +4.1% in 2022. That’s a significant increase from December’s estimate, where spending was anticipated to increase by just 2.7%. 2022 GDP estimates reflect a lower GDP, reduced to 2.8% from 4% in December. The FOMC sees a 3.5% unemployment rate by EOY.

What do these rate hikes mean for you?

• The Federal Reserve controls the federal funds rate, which is the target interest rate at which commercial banks can lend their reserves to each other. A bank's reserves describe the cash that banks have to keep in actual vaults to make sure they have enough liquid money to satisfy a large withdrawal. The federal funds rate is important because it affects unemployment, economic growth, and inflation in the U.S.
• The federal funds rate affects other interest rates that you may be familiar with, such as interest rates on home or auto loans. Why does this relationship exist? Well, the interest rate at which you have to pay back your car loan depends on the bank's individual rate for you (this is known as the prime lending rate), and your individual rate is directly related to the federal funds rate.
• You probably heard that the Fed is going to reduce its balance sheet and raise rates. When the federal funds rate is low, it encourages people to invest or take out loans (because you have less interests to pay back.) That’s why the Fed lowered rates during the pandemic in an effort to incentivize people to participate in the economy in spite of lockdowns. The Fed also started buying bonds and other securities — ‘increasing the size of its balance sheet’ — in a process called quantitative easing to help lower interest rates.
• Although lowering rates and increasing asset purchases was an appropriate short-term monetary response to the pandemic-era economy, low rates and printing lots of money causes inflation in the long run, which is where we are now.
• So if raising rates helps combat inflation, why is the stock market reacting negatively? Because higher interest rates raise borrowing costs, disincentivize hiring, increase credit card rates,  and generally slow down the economy (at least, temporarily.) And when the economy slows down, bonds become more appealing investments because they’re less risky — so investors are selling or switching to bonds to avoid losing money.

Free money from the Fed has been amazing for the stock market. Zero percent interest rates depress government bond rates, essentially forcing investors to bet on risky assets like stocks. Higher rates could be a challenge for the stock market, too, which has become accustomed to -- if not addicted to -- easy money. Markets have already experienced significant volatility amid concerns about the Fed's plan to fight inflation. 

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