This week, the U.S. Federal Reserve Board increased interest rates for the fourth time this year with another three-quarter point, or 75 Basis Points (BPS). This is the fastest pace at which the Fed has raised interest rates in decades. This week’s action by the Federal Open Market Committee (FOMC) brings the Federal Funds target rate to 2.25-2.5%.
In June, the stock market was unpleasantly surprised by the Fed’s aggressive steps to curb inflation with a similar 75 BSP increase. As a result, the market plummeted, officially putting the U.S. in a bear market. However, this time traders were prepared for the 75 BPS increase. In fact, the market reacted positively on the day of the increase, as the Fed also hinted that further rate hikes in 2022 might not be as steep.
The Fed originally set the goal of eight quarter-point interest rate increases in 2022, with hopes that such measures would reduce inflation to a targeted goal of 2%. However, June’s inflation reading of 9.1%, as measured by the Consumer Price Index (CPI), signaled that inflation was still hot and the Fed reacted accordingly this July.[i] Future rate increases will likely take place in the remainder of the year, but most hope the policy rate increases will not be as large as they have been this summer.
Interest rate increases are relevant because they slow the economy by making it more expensive to borrow money. This reduces large expenses, such as the purchase of a home by everyday consumers, for example. Interest rate increases also make borrowing expensive for corporations, who react by trimming expenses. Shopify, Netflix, and Robinhood are just a few of the companies who have announced layoffs in 2022. Negative financial news such as layoffs, production shortages, or missing earnings estimates generally send the stock price of the related company down, and the decline often spreads like a virus to other companies within the same industry, sometimes purely on negative consumer sentiment or guilt by association.
While interest rate increases are unpleasant, they are being enacted by the Fed to combat inflation, which can ultimately be a larger and more unpleasant problem. The Fed believes this action is necessary and prudent, even at the detriment of economic growth.
Critics say the Fed left money supply too loose post-COVID, and addressed inflation too late in 2022, leading to an inevitable recession. A recession has traditionally been defined as two consecutive quarters of decline in a country’s economic growth, as measured by Gross Domestic Product or GDP. In the U.S., GDP decreased by an annual rate of 1.6% in the first quarter of 2022. This was followed by a successive decrease in GDP of 0.9% announced this week, by the Bureau of Economic Analysis. [ii] However, the question remains, does this officially put the U.S. in a recession?
The White House and organizations like the National Bureau of Economic Research (NBER), a nonpartisan private organization which determines whether we are officially in a recession, noted that GDP alone, should not dictate whether we are in a recession. NBER takes account a number of monthly indicators such as employment, personal income, industrial production and consumer confidence in addition to GDP. [iii] Most notably, employment has been extremely strong with the unemployment rate at only 3.6% in June according to the Bureau of Labor Statistics.[iv]
However, unarguably, GDP is the most prominent and important measurement to indicate whether we are in a recession. According to George Washington University professor Tara Sinclair, historically, there has only been one time in the U.S. history (1947) when the country had two negative quarters of GDP and such period was not determined to be a recession.[v] With midterm elections around the corner, the argument over inflation, the recession, and the blame for such factors will most certainly get heated in the months to come.
We should keep in mind that the U.S. has recorded a recession 33 times since 1854.[vi] Although scary, many economists feel this sharp pullback is necessary to rebalance the economy’s supply and demand for goods and services, cool wage growth, and curb inflation. In the big picture, recessions are temporary and each time we have pulled through and grown to new market highs. In today’s market especially, rebounds tend to come swiftly after steep market declines. Therefore, rather than trying to time the market, a more prudent approach may be to have a diversified portfolio that will allow you to capture market growth, regardless of what asset class it happens in first (i.e.: U.S. large/small, International large/small, etc).
NBER measures a recession as starting at the peak of the expansion that preceded it and ending at the low point of the ensuing downturn. In other words, even though a recession is breaking news this week, we may have technically been in a recession since December 2021! Hopefully the bottom is around the corner, if it hasn’t happened already!
[vi] Bob Veres Insider Information