In the concluding episodes of the Fed’s rapid rate hike cycle, how should investors ready themselves for the plot twists ahead? The Fed has raised the fed funds rate 11 times since March 2022 to combat the inflationary forces precipitated by the Russia-Ukraine war. (The fed funds rate is the interest rate charged by depository institutions such as banks, savings and loans and credit unions charge for overnight loans.) The sequence of 25-75bps hikes per consecutive FOMC meeting has resulted in a combined 500bps increase in interest rates to the current 5.25-5.50% range over 16 months.
This contrasts with the relatively gradual pace of hikes of a combined 200bps (or 25 bps over nine hikes) in the three years post-Global Financial Crisis (GFC) era from December 2015 to December 2018.
Even though inflation and jobs data this year have been a tug-of-war between inflationary and recessionary readings, recent data in June and July suggest that the rate hikes designed to cool inflation have worked as we witness signs of disinflation (or a fall in the inflation rate) from the lower Consumer Price Index (CPI) data.
At Bank of Singapore, we believe that the Fed’s 25bps rate hike in July is its final one for the year as inflation eases. However, we expect the central bank to leave fed funds rate elevated at 5.25%-5.50% to keep inflation at bay and potentially induce a US recession to bring inflation back to its 2% goal. Though this year’s second quarter GDP growth beat forecasts, the US economy will likely slow further as the full impact of the Fed’s aggressive rate hikes is expected to weaken activity over the next few quarters. Our base case is for two consecutive quarters of US economic contraction starting from the fourth quarter of 2023.
The equity markets have staged a strong recovery year to date (YTD) amid expectations of disinflation, moderate jobs and wage growth accompanied by mild economic growth to achieve the sweet spot “Goldilocks” scenario of soft landing for an economy that is “not too hot and not too cold”.
Yet for most individual investors, economic uncertainty, interest rate volatility and gyrations in capital markets over the past 12 to18 months have prompted a level of caution. Recent surveys show that many investors have increased allocation to cash and cash equivalents in their investment portfolios this year. Higher deposit rates not only raised the opportunity costs of investment, but offer predictable investment outcomes compared to the variability of equity and bond markets.
However, this inflection point for the interest rate cycle may foreshadow re-investment risks for investing in cash and cash equivalents for investors as prevailing rates at time of renewals may no longer be offered at similar deposit rates or yields in 6 to 12 months’ time. Longer-term investors might want to re-assess the current opportunities across asset classes (including bonds, equities, alternatives) as this may be an opportune moment for rebalancing portfolios to adjust to the market conditions ahead.
What does this mean for investors?
For investors with long-term objectives, a well-diversified portfolio of cash, stocks, bonds, commodities and alternative investments calibrated to investment objectives and risk tolerance is the bedrock for building resilient portfolios.
This article first appeared in the Business Times.
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