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Michaël van de Poppe - 16 June 2022

Fed raises interest rates by 0.75%, what does it mean?

The markets were awaiting the decision of the US Federal Reserve with regards to the rate hike yesterday. As inflation has seen a massive increase, the Fed’s goal is to drive this back to healthy levels for which interest rates are its main tool. And considering the high potential impact of these rates on the different markets, all investors are paying extra attention to these hikes. 

Higher rate than expected

The Fed announced yesterday their decision to increase their funds rates by 75 basis points and put us at a 1.75% interest rate. An increase of 75 bps is the largest increase in a single meeting since 1994. Furthermore they announced that future hikes are not off the table, as they are depending on higher borrowing costs to dampen demand and employment rates. The Fed is targeting a 3.4% interest rate by the end of the year and made clear they will not be slowing down before they see convincing evidence of decreasing inflation.

While Powell indicated an increase of 50 bps previously, a 75 bps hike was needed because of a higher rate of inflation than they had expected in their March projections, as was the expectation of traders and investors. The inflation data from last week shows the fastest pace of price increases since 1981 in combination with the worst consumer confidence since the 1970’s. This recent data made the Fed change their plans, as a mild approach would not have been sufficient to tame inflation and demand. 

Going forward

Going forward the Fed expects additional hikes in July ranging from 50 to 75 bps. They’re hoping this will give them enough breathing room to decide what to do next. Expectations from the Fed are that a fund rate of 2% by summertime will not induce a recession, unlike expectations of market speculators. All in all, the Fed is keen on the fact that aggressive rate hikes will result in lower inflation.

High interest rates are not beneficial for risk assets. During times of high interest rates, capital flocks towards government bonds, especially in the US. This is because the (risk-free) yield on US bonds increases with higher interest rates, making them more attractive over (risky) equities.

It is because of these reasons that in times of declining interest rates, or near-zero rates like we’ve had some time in the past, investors start looking for other ways to generate a return, leading them to invest in riskier asset classes such as stocks and crypto. 

Since cryptocurrency acts as a risk-on asset, it would not be a bad idea to assume that the current bearish sentiment is going to continue and result in more downside. Seeing as a 75 bps hike was already priced in previously, we will have to wait and see how the markets react to the incoming hike in July. In case of a 75 to 100 bps hike we can assume a bearish sentiment resulting in a significant downturn. 

Eyes remain on inflation

Of course any decisions made will be dependent upon the inflation numbers, as the Fed uses those to determine their path forward. It will be safe to assume that a relief rally across the markets is not very likely if the inflation numbers do not come down. In the case of crypto we would like to argue that a relief rally could be a little bit more likely, because of the highly oversold territory it currently finds itself in, partly due to certain negative events in crypto recently.