The terminal rate in 2023
Fed continue to make hawkish calls for more rate increases
These are hot topics of late.
In 2022, after the Fed raised interest rates by 3 yards four times in a row, inflation has finally dropped significantly recently. However, has this reached a normal level? How much should the interest rate be raised to effectively curb the rise in inflation? How to decide between raising and decreasing interest rates?
Whether you’re a new investor or a pro, this article will help you better understand the interest rates so you can make sure your money is working smarter.
*The benchmark interest rate varies from country to country. In this article, we are mainly referring to the announcement by the Fed.
What exactly is the interest rate?
An interest rate is an amount we must pay back in addition to the amount borrowed. So, if we borrow $1,000, we may have to repay $1,050 due to the interest rate. This is how the bank earns profit: by charging us a higher interest rate on the money we borrow.
Why do we have to pay back more than we borrowed?
Due to the time value of money, a dollar today is more valuable than a dollar tomorrow. Interest rates reflect the cost of borrowing money as well as the expected return on a loan or investment.
What are interest rate hikes/ cuts?
When the Fed wants to make borrowing money more expensive, it may raise interest rates, which means that if we borrow money, we will have to pay back more (the interest). This would tighten the economy because we will be drawn to higher interest rates, making us more likely to keep the money in the bank and less likely to borrow money or buy expensive items such as houses and automobiles, which will reduce total economic activity.
When the Fed wishes to stimulate economic activity, it may cut interest rates, making us less eager to save money in the bank. This leads to a more “heated” market.
Briefly summarize, interest rates play a vital role in the economy by influencing consumers’ and businesses’ spending and saving decisions.
When will the Fed announce the interest rate decision?
The Fed typically holds eight scheduled meetings each year and once every six weeks to make interest rate decision, which is usually announced on Thursday between 2:00 and 3:00 a.m. UTM. An economic projection will accompany every two meetings. The following chart is the 2023 interest rate decision schedule.
|Meeting date||Economic projection|
|February 2, 2023||X|
|March 23, 2023||V|
|May 4, 2023||X|
|June 15, 2023||V|
|July 27, 2023||X|
|September 21, 2023||V|
|November 2, 2023||X|
|December 14, 2023||V|
What data affects the Fed’s interest rate？
The Fed’s interest rate decision is mainly influenced by four primary data sources: CPI (the Consumer Price Index), the monthly rate of U.S. retail sales, the number of initial jobless claims, and the number of non-farm payrolls.
Consumer prices indicate the level of inflation, the monthly rate of U.S. retail sales measures the market’s purchasing power, and the number of initial jobless claims and non-farm payrolls reflect the labor market situation.
How do interest rate hikes/cuts affect your portfolio?
The relationship between interest rates and stocks is complex and often highly contingent on prevailing market conditions. In general, however, when interest rates are low, stock prices tend to be high, and vice versa. This is because low-interest rates make it cheaper for businesses to borrow money and expand, which drives up stock prices. Conversely, when interest rates are high, it becomes more expensive for businesses to borrow money, leading to slower growth and lower stock prices.
For example, the daily chart below shows the short-term plunge in the S&P 500 after the June 16, 2022, announcement of a 75 bps increase.
When we examine the long-term data, starting in February 2022, when the Fed started to raise interest rates, the S&P 500 displayed a steady downward trend. It was not until July that the Fed’s hawkish stance tended to moderate and prices began to bottom out.
Interest rate hikes can influence the forex market indirectly. The currency’s value may appreciate due to an increase in foreign investor demand generated by the higher interest rates. Additionally, more capital may flood into the country as investors are drawn to stronger yields. Conversely, for interest rate cuts, the currency’s value may depreciate due to a decrease in foreign investors’ demand generated by lower interest rates. Lesser capital may flow back to the country as investors seek higher yields elsewhere.
It is widely believed that interest rates and gold prices are inversely related. Since gold does not yield interest, as interest rates rise, gold will become less attractive and will be redirected to other investments that yield interest, such as bonds.
However, there has been no significant correlation between rising interest rates and falling gold prices in the past. Instead, given the past patterns of the stock market and gold price reactions to interest rate hikes, the likelihood is that rising interest rates will negatively affect stock prices. As one of the risk heaven assets, a falling stock price may change the risk preference and cause fluctuation in the gold price.
The dollar is another element that influences the gold price. This is because gold is denominated in dollars. In theory, as the dollar falls in price, investors using other currencies may purchase more gold, making the gold more appealing and driving gold prices up. On the other hand, a higher dollar makes gold more expensive for these investors and imposes pressure on gold prices.
Why has the Fed Keeps Raising the Interest?
The Fed has been hiking interest rates primarily to curb inflation.
During 2022, the epidemic swept the world, coupled with the geopolitical crisis, which should have been a year of economic recovery, but instead led to a surge in energy and food prices. Therefore, in order to catch up with and curb the ever-increasing inflation, the Fed has rarely raised interest rates by 3 yards 4 times in a row!
After the Fed kept interest rates tight, according to recent data, inflation in the United States is decreasing. After exceeding a 9% annual rate in June, CPI inflation in November was 7%. Nonetheless, the Fed believes that the recent drop in the inflation rate is insufficient. Most importantly, while inflation is declining, it is still high in relative terms. There is a risk that inflation will not fall cleanly to 2%.
Therefore, the market has generally believed that the Fed’s terminal interest rate in 2023 will reach 5.125%, but senior market strategist Dominique Dwor-Frecaut believes that the Fed must raise interest rates to around 8% to bring the economy back to normal levels. Which means that, Fed still has to keep raising rate to win the war on inflation.
In conclusion, interest rate hikes/cuts play a vital role in the overall economy and have far-reaching effects on the stock market, house market gold price, currency, etc. While you can’t control the direction of interest rates, you can stay informed by following us on Facebook and Instagram to stay tuned with the market!
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