In my December 16 article, “The Fed: Another rate hike, but what’s next?”, I noted a 0.25 percent rate hike at the Federal Reserve’s Wednesday, Dec. 19 meeting was pretty much expected. True to expectations, the Fed imposed its fourth rate hike this year and the seventh since March 2017.
Accordingly, the focus of this meeting was not on the rate hike itself, but on the Fed’s projected number of interest rate hikes over the next two years. Before its meeting, the Fed had projected three more rate hikes in 2019 and another one or two in 2020. Now, the Fed expects just two more rate hikes next year and one in 2020.
But the financial markets still view this as excessive. Rate hikes, as designed, act to restrict economic growth to prevent the economy from overheating and consumer prices from skyrocketing. And this concern of the Fed derailing our economy with all its rate hikes was illustrated in the subsequent stock market sell-off.
Before Wednesday’s 1 p.m. rate hike announcement, the Dow Jones Industrial Average, DJIA, was up 381 points. But in the following two hours, the DJIA fell to end the day down 351 points. On Thursday, the DJIA lost 464 points. On Friday, it fell 414 points. Then on Monday, Christmas Eve, the DJIA lost another 653 points. In total, in just four days, the DJIA fell 1,883 points, losing 8 percent of its value.
So, what exactly triggered this four-day sell-off?
It’s painfully evident the markets viewed the Fed’s modest reduction of future rate hikes as woefully inadequate. Despite the current strength of the U.S. economy, many in the financial community expect economic growth to gradually soften. After its meeting, the Fed lowered this year’s expected economic growth rate from 3.1 to 3 percent. For 2019, the Fed lowered its projected growth rate from 2.5 to just 2.3 percent.
And therein lies the frustration to the Fed’s revised rate hike agenda. If the Fed is already projecting an underwhelming economic growth rate of just 2.3 percent next year, how could it conceivably plan two more rate hikes next year and another one in 2020?
For you economic history buffs, in the eight years (2010-2017) following the Great Recession, the U.S. economy plodded along at a very anemic 2.175 percent average growth rate. And during that time, the Fed kept interest rates low to further stimulate economic growth. But now, with a near-similar economic growth rate of just 2.3 percent projected for next year, what is the Fed’s answer? – raising interest rates which further constrict economic growth!
Unfortunately, the recent four-day carnage has left the financial markets grasping at straws. As I had previously opined, if the Fed had communicated a more “wait-and-see” approach to its future rate hikes, it could have served as a catalyst to an already beaten down stock market.
Make no mistake, rate hikes are a necessary tool to keep our economy on an even keel. Without them, our economy would overheat and consumer prices would soar. Rate hikes are simply the cost of strong economic growth. But by the Fed’s own projections, it sees no overheating of the economy nor surging inflation. In fact, it sees both in a decline.
Whether the Fed actually delivers on its rate hikes next year will be the topic of much debate. For investors, unfortunately, it adds another layer of volatility to an already turbulent stock market. On Wednesday, the DJIA surged 1,086 points – the first 1,000-point daily gain in the DJIA’s history – giving investors some element of relief.
The Fed is mandated by Congress to promote the health and stability of our economy and financial system. But the markets might be wondering if somewhere along the way, the Fed may have forgotten this job description.