Updated 2/28/22
When it comes to the stock market, there is one event that investors are keeping a watchful eye on: The March Federal Open Market Committee (FOMC) meeting from March 15-16. At this meeting, it is expected that the Federal Reserve will announce their first federal funds rate hike since the pandemic began. This rate hike will not only be the Fed’s tool to combat inflation, but the size and frequency of these rate hikes may have an effect on the market, good or bad. However, some questions we have heard recently echo two main sentiments: what exactly is the federal funds rate, and what is its significance? Today, we’d like to explore both of these questions.
When you hear in the news about rate hikes, they are referring to the federal funds rate (FFR). The federal funds rate is simply the interest rate that banks pay to borrow from each other overnight. While that may not sound significant, the FFR has a ripple effect on all aspects of the global economy. Other domestic interest rates are heavily influenced by the FFR, including mortgage loans and credit cards.
The FFR also influences the value of the U.S. dollar. Yield-hungry international investors are more likely to invest in economies offering higher yields, causing the U.S. dollar to rise in value. Add in the fact that roughly 60% of the global central bank currency reserves are held in U.S. dollars, and the majority of the world’s currency reserves have their value directly tied to the FFR. The effect on the U.S. dollar alone makes the FFR one of the most important interest rates in the world.
Now, what decision will the Fed be making at their March meeting? At this point, it is a foregone conclusion amongst investors that rates will be raised in an effort to combat the rampant inflation that I’m sure everyone has felt. However, there are two important aspects that investors are watching keenly: the size of the rate hike, and the frequency of future rate hikes.
Regarding size, analysts seem to be projecting two potential outcomes: a 0.25% raise, or a 0.50% raise. The 0.50% raise is the one that investors are watching closely, as it would imply that the Fed feels a need to speed up the rate hiking process by making larger increases. On the flip side, the 0.25% raise may indicate that the Fed still feels comfortable with their initial plan, and that they don’t believe inflation to become much more severe. When it comes to the frequency of the hikes, there are also some potential conclusions to be drawn. Investors may view frequent 0.25% rate hikes as a happy middle, as the Fed wouldn’t spook the market with a substantial 0.50% raise all at once, while also still acknowledging that they need to make a greater effort to raise rates than previously anticipated to combat higher inflation numbers.
Regardless of how the Fed meeting goes, the change in FFR will be felt on a global scale. While rising rates are not historically a death knell for stocks, there are certainly areas of the market that are more sensitive to interest rate changes than others (energy, financials, utilities, and technology to name a few). While we can’t know for certain what actions the Fed will take in two weeks, we do know that the actions taken in March will give the market a better glimpse into what the Fed is currently thinking regarding the risk of inflation and the health of the U.S. economy.
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