Smaller rate hike signals slower monetary policy tightening

The US Federal Reserve (Fed) raised rates by 25 basis points (bps) yesterday. This may be a good sign for investors as it signals a shift towards slower monetary policy tightening. This was the eighth rate increase in the past year and brings the target for the federal funds rate to 4.5%-4.75%.

The interest rate hike was expected. This rate increase was lower than the last increase of 50 bps on December 14, 2022, and the Fed still expects further rate hikes will come this year. Central banks like the Fed and the Bank of Canada increase interest rates as a way to help curb rising inflation costs. In the US, inflation is at the highest level it’s been in 40 years.

Along with trying to lower high inflation, CIBC Economics notes additional rate increases could be an effort to help push the bond market towards higher yields. CIBC Economics doesn’t expect the Fed to ease policy anytime soon, and expects another 25 bps rate hike to come.

Michael Sager, Executive Director, Multi-Asset and Currency Management at CIBC Asset Management, says the market consensus expects the Fed to begin easing its policy stance in the second half of 2023, after one final interest rate increase in the first half of this year. Yesterday’s Fed statement suggests this outlook remains too optimistic and we agree. Once policy rates reach their peak, we think they’re likely to stay there for an extended period, as the Fed continues to squeeze inflation from the economy.

How markets react throughout 2023 will depend on how the Fed (and other central banks) handles monetary policy. If the Fed does hold interest rates unchanged for an extended period once they peak, equity markets will face challenges in the short term. The Fed meets again on March 22, 2023.