At last, the US central bank has pulled the interest rate trigger, raising borrowing costs and flagging more to come. Wealth managers who have been used to an era of almost zero rates need to adjust. Here are their reactions.

The US Federal Reserve yesterday said that it will increase the benchmark borrowing cost by a quarter of a percentage point, or 25 basis points, to a range between 0.25 per cent and 0.5 per cent from near zero.

Further rate hikes are likely as it aimed to stem high inflation, now running at the strongest levels since the early 1980s. In February, US consumer price inflation rose 7.9 per cent from a year earlier.

While expected, the reality of the world’s most important central bank tightening monetary policy after more than a decade of ultra-low rates is sobering. It comes at a time when the economy is being hit by rising energy prices – likely also to be a big election issue in the November mid-term races. Russia’s invasion of Ukraine, and the massive sanctions imposed on Moscow, complicated the Fed’s thinking. 

In its statement, the Federal Open Market Committee said: “Indicators of economic activity and employment have continued to strengthen. Job gains have been strong in recent months, and the unemployment rate has declined substantially. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.”

“The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The implications for the US economy are highly uncertain, but in the near term the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity.

“The Committee seeks to achieve maximum employment and inflation at the rate of 2 per cent over the longer run. With appropriate firming in the stance of monetary policy, the Committee expects inflation to return to its 2 per cent objective and the labour market to remain strong,” it concluded.

Here are a number of wealth managers’ reactions to the move:

Charles Hepworth, investment director, GAM Investments
The Federal Open Market Committee delivered on its messaging adopted so far this year that rates need to go higher. Deciding on a 0.25 per cent increase in the discount rate, the Fed cautioned that inflation remains too hot for it not to act, despite financial conditions noticeably deteriorating this year. While they may need to appear hawkish with now stubbornly high inflation, it’s obvious that had the committee acted sooner they wouldn’t have needed to act so aggressively now. With a slowing economy and worsening financial conditions, it’s highly unlikely that their projected trajectory will be delivered.
 

Sekar Indran, senior portfolio manager, Titan Asset Management
As widely expected, the Federal Reserve took its first step in withdrawing the tidal-wave of post-pandemic stimulus with its first rate hike since 2018 amid 40-year high inflation. Despite rising recession risk, the Fed’s dot plot reaffirmed the market’s hawkish pricing going into the meeting of a further six hikes this year. The trade-off between stabilising inflation and economic output is growing wider as the New Keynesian theory of “divine coincidence” breaks down in the face of mounting negative supply-shocks. Historically, equity markets have rallied over the twelve months following the beginning of a rate hike cycle but this time around markets also have to contend with the prospect of quantitative tightening with a challenging macroeconomic and geopolitical backdrop adding to the volatility.

Salman Ahmed, global head of macro and strategic asset allocation, Fidelity International
As expected, the Fed hiked by 25 bps at today’s meeting. However, the main change was a big shift in dot plot where the median dot now shows seven hikes for 2022. In his comments Chair Powell indicated a consensus in committee to bring back price stability in the economy, including guidance towards starting QT [quantitative tightening]. We continue to think the Fed will eventually hike three or four times this year but the ensuing tightening conditions from a very hawkish Fed will damage growth. All in all, given our stagflationary baseline which was exacerbated by the Russia/Ukraine war, it appears that the Fed’s focus will be more on inflation fighting despite the uncertainty created by the Ukraine war based on today’s meeting. 

From an asset allocation perspective, we remain cautious on both equities and credit markets.

Ronald Temple, managing director, co-head of multi-asset and head of US Equity, Lazard Asset Management
The Fed signalled that it plans to move further, and quicker, than markets expected. With 10 rate hikes through 2023 and a shrinking balance sheet, the Fed appears to believe that the economy can handle not only a tax on consumers from commodity prices, but also sharply tighter financial conditions. While tough talk is important, the Fed needs to ensure that it doesn’t overshoot and turn a robust recovery into a recession.

Seema Shah, chief strategist, Principal Global Investors
Probably six months after they should have started raising interest rates, the Fed has finally started lift-off. But even the most anticipated FOMC meeting still managed to deliver a surprise: the dot plot shows seven policy rate hikes this year! With inflation already almost quadruple their target, the Fed is playing catch-up and clearly recognises the need to get back in front of the inflation situation.

Some investors may be concerned that the US economy is not sufficiently sturdy to digest that many increases. But keep in mind that seven hikes only just takes the Fed target rate back to where it was pre-pandemic. Back then, the US economy was looking robust and there were minimal fears of recession. Fast forward to today, and households are in arguably a considerably stronger state, with important excess savings to cushion them, while corporate balance sheets are also looking robust. Not to mention the fact that inflation is three times higher than it was going into the pandemic.

It won’t be easy – rarely has the Fed safely landed the US economy from such inflation heights without triggering an economic crash. Furthermore, the conflict of course has the potential to disrupt the Fed’s path. But for now, the Fed’s priority has to be price stability.