One and Done (Federal Reserve Update)

We are referring to “one and done” as it relates to the Federal Reserve and the Federal Open Market Committee (FOMC). The FOMC met last week to review economic and financial conditions, determine monetary policy, and assess the long-term goals of price stability and sustainable economic growth. In simple terms, the FOMC announced last Wednesday that they were increasing short-term interest rates (Fed Funds Rate) by 0.25% (25 basis points) for a target range of 5-5.25% which we believe will be their final interest rate increase for the near term.

Why the Federal Reserve (Fed) matters?

The Fed and the FOMC matter because they determine interest rates which impact businesses and consumers. If you have requested a new mortgage or have leased a car recently, you are acutely aware that the cost of your mortgage or car payment has increased dramatically from where it was just a year and a half ago. On December 30, 2021 the St. Louis Federal Reserve reported that the average 30-year mortgage rate was 3.11% and on May 4, 2023 the rate was 6.39%. On a $400,000 mortgage, the monthly mortgage cost is $2,499 today versus $1,710 in late 2021 for an increased cost of $789 per month according to data obtained from BankRate.

Why has the Fed been raising rates?

The Fed has a dual mandate to pursue the economic goals of maximum employment and price stability. With unemployment at 3.5%, the goal of maximum employment has been accomplished. In regards to price stability, commonly referred to as inflation, the Fed is raising rates to slow down the rate of price increases being experienced by consumers and businesses.

Why do we believe that the Fed was one (rate increase) and done last week?

We believe that the Federal Reserve increased short-term interest rates one final time last week in order to send a message to the markets that they are serious about taming inflation. While inflation still remains elevated, it appears to be moderating and that is reflected in the cost of numerous goods and services including shelter, food, and other expenses.

Several reasons why we believe the Fed is one and done:

• Consumer Price Index (CPI): Inflation continues to decline from its peak level in June 2022 as illustrated by the chart below which indicates rate hikes by the Fed can be deemed successful.

• Leading Economic Indicators (LEI): The LEI includes the following: Average weekly hours in manufacturing, average weekly initial claims for unemployment insurance, manufacturers’ new orders for consumer goods and materials, ISM^® Index of New Orders, manufacturers’ new orders for nondefense capital goods excluding aircraft orders, building permits for new private housing units, S&P 500^® Index of stock prices, Leading Credit Index^™, interest rate spread (10-year Treasury bonds less federal funds rate), and average consumer expectations for business conditions. The chart below clearly indicates that the economy is slowing and that the need for additional rate increases is unwarranted.

• Bank Failures: With the recent collapse of Silicon Valley Bank, Signature Bank, and First Republic, the Federal Reserve is cognizant of the combination that higher interest rates and poor balance sheet management at a number of banks is having on many institutions. The chart below does not include First Republic, but doing so would only increase the bar graph indicating the total assets associated with the three failed banks.

What advice are we giving our clients?

If you have a large balance in your savings or checking account, we would recommend redeploying the funds into a higher yielding money market account such as the Value Advantage mutual fund at Schwab where the current yield is 4.85%. In addition to putting idle cash to work, we are using the higher interest rate environment to rebalance portfolios and increase exposure to fixed income investments which are currently offering a more favorable yield than they were just over a year ago. This results in less volatility (risk) within an investment portfolio.

In addition to increasing your fixed income exposure, we are using the favorable interest rate environment to obtain more favorable terms for new market linked notes. We have five notes maturing during the remainder of this year, so the increase in interest rates allows us to obtain terms that offer either more downside protection or higher upside participation. This is another benefit of how an increase in interest rates is benefiting your portfolio.