Update from the Federal Reserve

The Federal Reserve's Open Market Committee held its final meeting of 2022 on December 13th and 14th. Out of that meeting came one last rate hike for 2022.

After four consecutive rate hikes of 0.75%, December's was a slightly lower 0.50%, bringing the overnight rate to a range of 4.25-4.50%. This move was widely expected after previous comments from Fed governors and based on the most recent inflation readings, which showed moderation in the inflation rate. So does this mean investors now see a light at the end of the rate hike tunnel? Before getting too excited, we recommend a quote from Churchill: "Now, this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning."

While the switch from a 75-basis point to a 50-basis point hike may not seem like a huge deal, it is an important shift. The problem with interest rate policy is that while rate hikes go into effect immediately, their impact on the economy as a whole takes a lot longer to work through the system. Raising rates by ¾ of a percent at a time is a very blunt approach to a nuanced problem. Perhaps such an approach was prudent at first since the Fed initially dismissed the growing inflation issue as "transitory." However, by lowering the pace of increases, the Fed gains more time to gauge the effect of hikes as their impact works through the economy. This should help them avoid going overboard and inflicting more damage than necessary while fighting the problem of higher-than-desired inflation.

The Fed's forward-looking commentary was possibly more important than the most recent hike itself. The Fed may be slowing the pace of increases, but that is far different from stopping them altogether, let alone reducing them. In fact, on average, the Committee anticipates rates peaking at 5.0-5.5% next year, above the previous estimate of 4.6%. That implies that we still have a ways to go before we get to the end of the current rate hike cycle. This could mean more headwinds for equity and fixed-income markets if the Fed is committed to keeping monetary policy tighter for longer than expected.

As always, the Committee members will react to data as it becomes available. Of course, if we see a continued deceleration of inflation readings, rate hikes may end sooner rather than later. But the finish line remains in the distance at this point.

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