Implications are on the horizon for investors and markets after the most significant rate hike since 1994.

This rate hike was one of the most predictable and predicted rate movements the markets have ever seen. However, the magnitude of the rate hike was unforeseen. While markets and traders were expecting this hike, the announcement contributed to the DJIA, NASDAQ, and the S&P 500, rallying by more than 1%. But within a few hours after markets closed, the futures market suggested that gains would deplete by the following day.

Keep in mind that’s only one trading day and one futures “night.” Long-term investors should consider the risk if the Fed continues moving rates higher and faster than expected throughout 2022. Then, we could see some longer-term challenges for the stock market and consumers. Higher rates are uncertain to happen for the remainder of the year. The magnitude, however, depends on several factors.

“Today’s 75 basis point increase is an unusually large one, and I do not expect moves of this size to be common,” said Fed Chair Jerome Powell. Powell also said that decisions will be addressed “meeting by meeting.”

Interestingly, as of the day after the Fed’s historic announcement, Wall Street assigned a probability of more than 80% that the Fed would raise rates by another 75 basis points at their next meeting at the end of July. So, will there be implications for this announcement? Sure. But enough to make most investors change allocations or courses of action? Maybe. Maybe not.

From the Federal Reserve press release dated June 15, 2022:

“Overall economic activity appears to have picked up after edging down in the first quarter.  In recent months, job gains have been robust, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures. The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The invasion and related events are creating additional upward pressure on inflation and are weighing on global economic activity. In addition, COVID-related lockdowns in China are likely to exacerbate supply chain disruptions. The Committee is highly attentive to inflation risks.

The Committee seeks to fulfill maximum employment and inflation at 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 1-1/2 to 1-3/4 percent and anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee will continue reducing its holdings of Treasury securities and debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve’s Balance Sheet issued in May. The Committee is strongly committed to returning inflation to its 2 percent objective.”

Reason to Change

The most important tool available to the Fed is its ability to set the federal funds rate, or the prime interest rate. The federal funds rate is the interest banks pay to borrow money from the Federal Reserve Bank. Interest is the cost to the banks of borrowing someone else’s money. The banks will pass on this cost to their borrowers. Increasing the federal funds rate reduces the supply of money by making it more expensive to obtain. Thus, reducing consumer and business spending in an attempt to control inflation.

Effects on Consumers and Businesses

Any increased expense for banks to borrow money has a ripple effect, influencing individuals and businesses in their costs and plans.

  • Banks increase the rates they charge to individuals to borrow funds through increases in credit card and mortgage interest rates. As a result, consumers have less money to spend and must face the effect of what they want to purchase and when to do so. In other words, mortgage and credit card interest rates are trending up. The same is true with auto loans.
  • Because consumers will have less disposable income (in theory), businesses must consider the effects on their revenues and profits. As the banks make borrowing more expensive for businesses, companies are more likely to reduce their spending. Less business spending and capital investment can slow economic growth, decreasing business profits. These broad interactions can play out in numerous ways.

Effects on the Markets

This one is a bit trickier because stock prices should decrease when investors see companies reduce growth spending or make less profit. But the reality is that stocks often do well in the year following an initial rate hike. The Fed typically won’t raise rates unless they deem the economy healthy enough to withstand what should slow it. But after multiple and large rate hikes in the same year? Much tougher to predict.

If the stock market declines, investors tend to view the risk of stock investments as outweighing the rewards, moving toward the safer bonds and Treasury bills. As a result, bond interest rates will rise, and investors will likely earn more from bonds. Many factors affect activity in various parts of the economy. A change in interest rates, although important, is just one of those factors.


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