Fed Rate Hike Analysis – Interest Rates Up 75 bps; What It Means for Investors

As the Fed continues to push interest rates higher to combat inflation (today announcing a 0.75% increase), investment professionals from across the Catalyst Funds and Rational Funds network weigh in on what this could mean for investors:

Leland Abrams, Wynkoop Financial and Portfolio Manager of an Income Fund.

• The knee jerk reaction to sell the entire yield curve was the wrong one. Two-year yields briefly climbed above 4.1% (their highest since 2007), dropped below 4% and settled in at the close around 4.05%.  They appear to be a great buy. They’re now likely headed back to the 3%’s.
• It is likely that the more aggressive front loading of rate increases will be like tearing off the Band-Aid. The Fed’s outlook for longer term rates is around 2.5%.
• During the Q&A portion of the Fed press conference, rates reversed their knee jerk sell-off and caught a bid across the curve (particularly in the longer end); huge curve inversion (2s/10s around 53 bps inverted).
• Chair Powell told the WSJ’s Nick Timiraos that “we have arrived,” while noting the softness in the housing market on several occasions. Powell also avoided a question about selling MBS given the housing market softness, which we interpret as they’re not going to be selling MBS.

  “We said we would consider that once balance sheet runoff is well under way. It’s not something we’re considering right now and not something I expect to be considering in the near term. It’s something we will turn to, but the time for turning it to is not close.”

• In summary, we see an opportunistic environment to BUY BONDS – 2-year and 3-year bonds are currently very cheap.

Hunter Frey, Investment Analyst at Catalyst Funds, Rational Funds, and Strategy Shares:

• The Federal Reserve raised interest rates by another 75 basis points with guidance that additional rate hikes are necessary to tame inflation. A majority of Fed officials (based on the dot plot) are in favor of the terminal rate peaking at the end of this year at around 4.6% (suggesting a fourth straight 75 basis point rate hike in November). Additionally, policy makers expect rates to be cut in 2024 to about 3.9% and 2.9% in 2025 (though those remains lofty estimates).
• Growth is also expected to slow with GDP growth marked down to 1.2% in 2023 and 1.7% in 2024 with unemployment expected to rise to 4.4% in 2023 (in line with our internal forecasts).
• As we have been warning for over 1.5 years, we believe that stagflation remains a tangible threat to portfolios supported by increasing unemployment forecasts and inflation likely to persists above the Fed’s 2% target through 2025. This also highlights the statistical difficulty in accomplishing a soft landing though a growth recession seems more likely – though also challenging.
• Equity markets will remain volatile with Treasuries likely to continue to flirt with historic highs. Equity investors should look past the intraday volatility and focus on quality, valuation, and structural innovation leaders for long-term time horizons – as this can be a trough in markets amid September seasonality. Credit investors should seek uncorrelated returns in fixed income markets with a short duration tilt to decrease yield curve risk.

Daniel Rudnitsky, SMH Advisors, and Senior Portfolio Manager of an income strategy:

• The Fed is raising rates higher and for longer than projected for 2022 and 2023 and likely coming back down in 2024. We are likely to see 75 bps, 50 bps, and 25 bps increases depending on the data over the next 3 FOMC meetings.
• We expect to see housing continue to soften, but not disastrously. Commodities are likely to continue to soften as well, and unemployment will likely go up with top line labor prices stabilizing.
• Below investment grade bonds will see an increase of defaults in already-marginal companies. Over the last few years, most below investment grade companies took advantage of low rates and shored up balance sheets.
• The yield on the 30-year UST has come down, which means that the bond market is expecting the Fed to bring inflation under control. Expectations are that this will eventually turn into a slow growth, low inflation, and low interest rate environment.

• Our forecast is that returns across most asset classes will go back towards their 20-year averages and be single digits. Investments that produce cash flow will be important.

Joe Tigay, Equity Armor Investments, LLC, and Portfolio Manager of an Alternative Equity Fund.

• There is a lot going on in the world right now. Our eyes are justifiably on the Fed today, but we can’t sleep on the rest of the world. We know volatility in one market causes waves of volatility to flow to the next market. What the Fed did today will have ripple effects around the world.
• China is in the middle of a currency crisis. The nice thing about pegging to the dollar is that the trade with the dollar does not get disrupted. However, when the dollar appreciates so much in such a short period of time, it causes some major disruptions for the pegger. It is comparatively cheaper for US consumers to buy products from outside of China now, such as Japan and Europe. Will China de-value? What will the ripple effects be to the region and world? Following the Fed’s interest rate announcement, we saw the dollar rise, exacerbating the problem for China.
• Eurozone rates are rising as Italians head to the polls. Inflation hitting at a time of economic slowdown is such a hard pill to swallow. There is less maneuverability for central banks and government to pull out of a recession. For countries entering this period with a high debt to GDP ratio, it means big problems. Globally, politics are at a point where making hard choices about government spending is very difficult, raising the prospects for a major government default.
• In addition to all this, there is still a war causing upward pressure to prices. And with the recent Russian mobilization, there is little hope for it ending any time soon.