Monetary Policy Institutions Hike Again, But the Thrill Appears To Be Gone

A handful of monetary policy institutions hiked benchmark rates this week. The Reserve Bank of Australia raised its cash rate target 25 basis points, or bps (0.25 percentage point, or ppt) Tuesday, bringing it to 3.85%.^[i] The US Federal Reserve (Fed) also raised its benchmark rate by another 25 bps Wednesday, bringing the fed-funds target range to 5.0% – 5.25%.^[ii] And rounding out the rises, the European Central Bank (ECB) hiked its benchmark rate bps Thursday, bringing it to 3.25%.^[iii] From publications we read and market-based indicators we follow, it appears the world had largely already pencilled these moves in, which may be why a slight tweak to the Fed’s statement grabbed most of the attention from commentators we follow, fuelling their assertions that the Fed is likely done for now. As always, we wouldn’t read into the Fed’s words. But whether the Fed or other monetary policy institutions are done or keep hiking, we doubt it means much for stocks.

In past statements, the Federal Open Market Committee (FOMC, the cadre that makes US monetary policy decisions) has included this language: “The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the extent of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”^[iv] This time, the first of those two sentences was gone, whilst the second returned with some slight modifications. Even though it referenced the potential for future tightening, the absence of the “some additional policy firming may be appropriate …” bit is ratcheting up commentators’ theorising that the era of rate hikes is over.^[v]

Maybe it is. Back when the Fed raised interest rates in 2004 – 2006, 5.25% was the peak fed-funds rate.^[vi] In his post-meeting press conference, Fed head Jerome Powell also acknowledged that the tighter credit conditions following the failures of Silicon Valley Bank, Signature Bank and now First Republic had done some of the FOMC’s work for them. “We won’t have to raise rates quite as high as we would have if this had not happened.”^[vii] But also, we think it is entirely possible they keep going. Powell reiterated the Fed’s time-honoured mantra that decisions are data-dependent. The statement stressed that point, too. Who knows how the 11 FOMC members will interpret the data arriving between now and June’s meeting. Or even what data they exactly emphasise or disregard, and what they think said data should do ahead. Or how that will all evolve by July’s meeting and beyond. Anything is possible, and you can’t predict it in advance. Case in point: Australia’s aforementioned rate hike followed a pause at its March meeting. None of this is on a preset course.

Whether or not the Fed or other monetary policy institutions have more rate hikes to go, we see good reason to think stocks aren’t likely to mind much. As Exhibit 1 shows, US stocks have risen alongside Fed rate hikes for over half a year now. The S&P 500 may be down since rate hikes began in March 2022, but only by -3.7% in US dollars (to avoid skew from last year’s big currency swings), and they are up since the first 75 basis-point hike last June.^[viii] Our research shows another hike or two wouldn’t much change overall banking conditions, considering that even with their recent increase, most bank deposit rates remain well below fed-funds.^[ix] Movement on that front seems tied more to overall market conditions than what the Fed does, in our view.

Exhibit 1: Rate Hikes Don’t Appear to Have Pre-Set Market Impact on US Stocks

Source: FactSet and US Federal Reserve, as of 3/5/2023. S&P 500 total return index in USD, 2/5/2018 – 2/5/2023. Currency fluctuations between the US dollar and pound may result in higher or lower investment returns.

This is true outside America as well. The Bank of England was the first major monetary policy institution to start hiking rates on 16 December 2021.^[x] Since then, the MSCI UK Investible Market Index (IMI) is up 8.8% in pounds.^[xi]

Exhibit 2: … Or UK Stocks

Source: FactSet and Bank of England, as of 3/5/2023. MSCI UK Investible Market Index (IMI) total returns in GBP, 2/5/2018 – 2/5/2023.

The ECB was late to the party, starting on 21 July 2022.^[xii] MSCI’s eurozone index is up 19.9% in pounds and 16.1% in euros since then.^[xiii]

From our vantage point, sentiment in the investing world seems stuck in the perception that rate hikes fuelled last year’s downturn, and we think they probably did contribute to the deep pessimism that Fisher Investments’ research finds weighed on markets (along with inflation, oil prices and a host of others).^[xiv] Perhaps the fact the early hikes came as part of monetary policy institutions’ 180-degree turn on inflation added to observers’ surprise. But to us, returns since last summer arguably tell a different story, one of stocks’ resilience and ability to get over widespread fears.^[xv] We think it is time more investors started noticing.