Josh Dudick, Wealth of Geeks
All eyes are still on the Fed as investors head into 2023 to see how firmly the central bank will stick to its hawkish path of raising interest rates and tightening balance sheets.
Bullish investors smell a pivot around the corner. Inflation is in decline, and the economy is slowing, so the Fed will soon step back from the brink of pushing the economy into recession.
Recent history supports this thesis. In 2016 and 2018, the Fed’s sustained hiking into a slowdown triggered a broad market sell-off. In both instances, the Fed soon corrected course, and stocks soared after the rate hike pause.
Yet others warn not to underestimate the Feds’ resolve. Both JPMorgan CEO Jamie Dimon and Morgan Stanley’s CIO Mike Wilson this month cast fresh doubt on the imminent pivot, predicting the Fed will not appease investors that easily.
In the latest installment of Fed-watching, several policymakers at the institution indicated they wish to see rates reach at least 5% before hitting the pause button.
Fed policymakers want to make sure inflation is stamped out for good, according to Reuters . Many are worried ending rate hikes too soon will allow prices to creep back up, requiring more policy-driven pain further down the road.
If rates do indeed go higher still and stay there for longer, it could substantially alter the market dynamics for the year ahead. This article will examine how monetary policy will continue to shape investors’ outlook this year and how to prepare by adjusting to your personal investment plan.
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Where we are
Following the Fed’s most recent meeting on February 1, Fed Chair Jerome Powell announced that the central bank will bump up the target range for their benchmark overnight lending rate slightly.
Prior to the meeting, it sat at 4.25% to 4.50%. As of February 2, 2023, the new target range will be 4.50% to 4.75%. The incredible jump from early last year - when the policy rate was in the 0%-0.25% range - is the fastest period of monetary tightening in at least two decades .
The markets have been struggling to find their feet amid the uncertainty.
The S&P 500 has been fluctuating between 3,800 and 4,000 points over the past few weeks.
The general trend has been a slope downwards, punctuated by brief rallies, the latest lead by news of Netflix’s surprise subscriber gains and Google’s slimming workforce.
Crypto markets have been in a better mood this month, with Bitcoin staging a surprise comeback, gaining almost 30% since the start of 2023. The world’s largest digital asset sunk and settled around $16,000 late last year after the sudden collapse of mega-exchange FTX damaged the industry. Investors are weighing up whether or not this latest rally signals the bottom is in, and a “secular bull market” may be reemerging for digital assets.
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Traits of the rates
The influence of interest rates on market prices is complex and not always clear-cut. However, a few observable trends are worth noting.
Higher interest rates tend to suppress prices on both the stock and crypto markets. This is partly because higher rates divert capital into other asset classes. For instance, higher interest rates make assets like bond yields more attractive, which, in turn, lightens demand for crypto and stocks.
Higher rates also make borrowing much more costly for institutional investors and retail investors who use leverage to trade on the margins . Similarly, higher rates make borrowing more expensive for publicly-traded companies themselves, which limits their profitability and further lowers their price in the market.
This mostly holds for digital assets too. Once the pariah hedge against traditional investments, crypto has become more closely correlated to stock market indices since the pandemic. Investors in the space can no longer ignore what the Fed is up to, as the importance of rate changes holds across the board.
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Balancing and hedging
Jerome Powell isn’t the only one adjusting, though. Investors can and should make adjustments to their portfolios in response to several factors in order to steer them through this time.
A thorough review of your personal investment plan should be done at least once per year. However, during times of uncertainty, investors may consider doing so every quarter.
Diversification is always a prudent strategy but becomes even more critical during a downturn. The shorter your investment horizon, the more vulnerable you are to volatility.
Those who are fast approaching their investment milestones may want to safeguard their portfolio by retreating into safer, defensive assets. These include treasury bonds, gold, or so-called “recession-proof stocks” that boast low volatility and strong dividend yields. This could also involve opting for preferred stock over common stock since the former typically offers fixed dividends.
For younger investors, however, there is usually more time to recover from setbacks. If approached correctly, a downturn can become an opportunity to make gains over the long term by buying up valuable stocks for a discount. One stock market crash strategy recommends divvying up a cash pile and gradually buying into the market as it falls incrementally lower. As always, investors should tailor their approach to suit their risk profile and realize their financial goals.
It is unclear when or how the fog will lift from the market. Yet, with so much riding on interest rates right now, it is imperative to prepare for all possible outcomes. By taking precautions and planning ahead, you can best prepare and avoid being caught wrong-footed by sudden policy changes.
