The End of Interest-Rate Hikes: Are We There Yet?

Chris Keith

Senior Vice President, Fixed Income Manager

Curious bondA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. investors everywhere want to know: Are we there yet? “There” refers to the end of the Federal Reserve’s interest-rate-hiking cycle. It’s not a certainty, but our view is that the Fed is on the cusp of shifting policy.

The economy may be weakening, which supports this view. Softening data from areas including retail sales, GDP, initial jobless claims, job openings, the service sector and home sales all point to slower economic growth.

The Fed is close to the end of the rate-hike cycle

In particular, inflation’s “sticky” components—the cost of recreation, personal care products, medical care and certain other categories of spending—have not eased as much as the headline number. Higher prices in these areas are supported by the strong job market, which props up consumer demand. Winning the inflation battle through monetary policy will take more time.

But that doesn’t require the Fed to hike rates continually. It can combat the problem by maintaining the current level of rates. Typically, when borrowing costs are high, consumers borrow less and spend less. That results in a drop in demand that is followed by a drop in the cost of goods and services. By leaving rates where they are, the Fed can passively work to cool the economy further. This is where the “higher for longer” policy comes in.

So, what happens next? Like many investment markets, the bond market can be forward-looking, and in this case, that applies to where rates are headed. Many analysts believe the Fed will cut interest rates before the end of 2023. It may do just that, but we think it’s unlikely with the current level of inflation. Barring a bigger problem within the banking sector or any other major economic event, we believe a more likely scenario is that the Fed will stop hiking and stand pat.

The takeaway for investors is that some yieldsYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price. are lower than they were in Q4 last year, but they remain rewarding compared to where they were a full year ago, as illustrated in our data box above. And if you’re reinvesting dividends and income, a policy of higher rates for a longer period will benefit you because you are buying new bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates. (or bond fund shares) while they are offering higher yields.