After the Latest Fed Rate Hike, More Questions Than Answers for Investors About the Outlook

Ivana Hampton: The Federal Reserve faces a double dilemma – high inflation and a banking crisis. Wall Street watched and predicted the Fed’s next move. As the Fed hiked rates by 0.25 percentage point, Tom Lauricella, Morningstar Inc.’s editor-in-chief of markets and smart investor newsletters, is here to discuss the decision and the future.

Tom, this wasn’t your usual Fed meeting. The Fed Has Raised Rates, But What Was The Focus Today?

Tom Lauricella: Yes, this wasn’t your typical Fed meeting all about what the Fed is going to do on interest rates. Things really changed with the advent of this banking crisis a few weeks ago and that became a big part of the focus. As far as we could tell, that seemed to be a big part of the focus of the discussion at the Fed meeting. And certainly at the press conference, many questions from reporters to Fed Chair Powell revolved around the impact of the banking crisis, the state of affairs and what this will mean for the economy and monetary policy going forward.

Hampton: Now, given the importance of the banking crisis in the Fed’s discussions, what have they told us about their thinking?

Laurel: The first thing investors should remember, and we’ve written about it, is that banking crises really aren’t just about the banks. Banks are a key, a key cog in the economy, and the Fed knows that. I mean, part of their mandate is to make sure the banking system is stable and working well. So essentially what the Fed has been telling us is that they are trying to gauge the impact that this banking crisis will have on the economy. Fed Chair Powell went out of his way to say repeatedly that the banking system was healthy. It’s stable. It seemed like they really wanted to try to send a clear message to people not to panic and withdraw their money from the banks. The Fed would like to avoid this kind of crisis of confidence at all costs. But when it comes to the implications for the economy and monetary policy, things get a lot muddy here. There is much more uncertainty about what the impact will be and what it really means for the interest rate outlook.

Hampton: Now there were many questions about the prospects for rate hikes. What was the message for investors?

Laurel: The key message for today’s investors is that the Fed still sees the need to keep interest rates high. They signaled that they are probably very close to the end of the interest rate cycle. Well, that’s different from December and even just a few weeks back when it looked like the Fed was clearly on course for more rate hikes. The phrase they used was “ongoing rate hikes.” So this message has changed significantly. The Fed sees no need for further rate hikes. We could still see one more, according to Fed projections, but the idea that it’s somehow open at this point is completely off the table. So that’s a big change that we saw at this meeting.

Hampton: What does this mean for the economy as a whole?

Laurel: Well, that’s the question. And even Fed Chairman Powell – he doesn’t have a crystal ball. It is difficult. Nobody really knows at this point. The question here is to what extent banks will continue to tighten their lending standards, to what extent banks will make it more difficult for individuals and companies to borrow. This is really critical. Lending is essentially the fuel that drives an economy, and when banks limit their lending, it can really stall economic growth. Fed Chair Powell said it was too early to say at this point. The Fed watches these things very closely. He was asked directly: What does this mean for the prospects for a soft landing? He said it’s just too early to tell at this point.

Hampton: Now, what are some of the signs that investors or people on Main Street can see when lending slows down?

Laurel: Yes, that’s a bit harsh. That happens behind the scenes. The Fed reports the level of ongoing lending, or bank reserves, every week. They regularly publish reports of what they hear directly from lenders. But it’s really something that people will see when they take out a loan; It can get harder to get a credit card. We spoke to an analyst who gave the example of someone wanting to open a new dry cleaning business. A few weeks ago they might have gotten a loan. If you go to your small or medium sized lender today, unless you have perfect credit, you may not get that loan. It will materialize bit by bit. This takes some time to play out. Morningstar chief economist Preston Caldwell notes that this could play out over the next few quarters. It’s not something that just – hopefully, anyway – shuts everything down overnight. But this is something that is happening slowly. I mean just think about it. You don’t need a loan that often. But when the time comes and you need one and you thought you could get one and you can’t, that makes a world of difference.

Hampton: Well, the focus of this week’s session series has been on the banking sector and that’s a big change from previous sessions. Where did the discussions about inflation turn? I mean, with this walkthrough, is the Fed worried about inflation?

Laurel: They very well are, and that was sort of what the Fed has to make up for here is that inflation is still running very hot. The latest number we had was that CPI inflation was 6%. That’s far, far above the Fed’s target. The Fed is well aware of this. You are in this bond. You have to watch this banking crisis unfold. It is unclear to what extent that will be. But they also can’t keep an eye on the inflation ball because inflation is very hard to wipe out. So if the Fed simply changes course completely and just focuses on supporting economic growth, there is a risk that inflation will return. And Morningstar’s Preston Caldwell has pointed out that if the Fed is indeed successful in containing this crisis, it may have to work harder to keep inflation low because the economy has been really strong. So if this doesn’t heat up the economy, slow it down, the Fed may have a lot more work to do. It’s a weird position we’re in right now, very insecure.

Hampton: It’s definitely a situation where we have to watch and wait. So, putting it all together, what are some of the takeaways or key areas for investors to consider?

Laurel: One of the key areas to watch is the divergence between what markets are expecting and what the Fed is telling us. The markets are actually very skeptical about the Fed’s forecasts. The market expects the Fed to start cutting rates by the third quarter of this year. That’s perhaps a bit premature. But investors should keep this in mind: How is the market adjusting to what’s happening out there? We’re going to have to keep an eye on some of the more recent economic indicators to see if things are turning for the better, if jobless claims are starting to rise, those bank lending stats. There’s a lot to consider out there. It’s not the usual focus. It’s not just the stock market. Investors really need to pay attention to some of these other things that they don’t usually watch, and a lot of that has to do with the bond market and these banking indicators. There’s definitely a lot for investors to digest right now.

Hampton: And I’m sure your team will be there. Thank you Tom for taking the time today.

Laurel: Glad to be here. Thanks.

Hampton: Subscribe to the Smart Investor newsletter. You can catch Morningstar’s weekly synopsis of how they think about major market trends and investment opportunities. I’m Ivanna Hampton, Senior Multimedia Editor at Morningstar.