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the bark is worse than the bite

the bark is worse than the bite

the Fed interest rate hike cycle has finally begun and its impact appears to be not nearly as bad as feared
March 21, 2022
3 min read
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the Fed interest rate hike cycle has finally begun and its impact appears to be not nearly as bad as feared

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on March 16, the US Federal Reserve raised its benchmark short-term interest rate for the first time since 2018. while implementing an immediate price hike of 0.25%, it also laid out its plans for seven such hikes overall in 2022, leading to an interest rate of 1.875% at the close of the year. this essentially means money will get costlier to borrow for other banks - from the central bank - an effect which will move further down the lending chain, ultimately making it costlier for businesses and individuals to access capital.

despite this, global markets appear to have been sparked into cheerful spirits. here’s why.

deflating the bubble

the main reason behind this move is the Fed’s stated intention of reducing the inflation rate in the US to a target rate of 2%. while this will take several months and possibly even years to achieve, it was inevitable that the interest rate hikes begin now. there has been criticism from several analysts that the Fed has already waited too long and allowed the inflation rate to reach record highs of nearly 8%.

the risk with having let it get as high before implementing the rate hikes is the potential of ‘stagflation’. this refers to a scenario where both unemployment and inflation rates remain in excess of 5% for an extended period of years, ultimately leading to a recession. in the short term, all types of credit such as debt, car loans, mortgages and credit card payments are set to get costlier to repay.

while in India, the RBI appears in no such hurry, the US central bank being followed by many other major ones across the globe might force its hand into implementing a rate hike as well.

bottomed out

there’s an oft-used adage in the world of investors, ‘buy the rumour, sell the news’. an inverse version of it appears to be playing out now. the markets have remained in a downturn for quite a while in anticipation of the Fed’s rate hikes. but now that they have finally begun, the response appears to be a reversal of that trend. Wall Street in particular had a very positive reaction to the news, which is actually in line with the S&P 500’s average annualised growth rate of 9.4% during the previous 12 interest rate hike cycles.
also spurring the positivity were news of China’s promise to roll out more stimulus to stabilise the economy and an apparent breakthrough in the direction of peace in the Russia-Ukraine conflict.

as with cryptocurrencies or with anything in general to do with markets, uncertainty is the enemy and that is something the Fed appears to have eased by making its intentions for the remainder of 2022 clear. additionally, a fairly long streak of selling means the markets currently offer attractive valuations on several investment opportunities. the result might be an upward rally which sustains at least over the short term.