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

Why investors should keep close watch on ripples from the banking crisis. 

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

Ivanna Hampton: The Federal Reserve is dealing with a double dilemma—high inflation and a banking crisis. Wall Street was watching and predicting the Fed’s next move. While the Fed raised interest rates by 0.25 percentage point, Morningstar Inc.’s chief markets editor and Smart Investor newsletter editor, Tom Lauricella, is here to discuss the decision and what’s ahead.

Tom, this wasn’t your usual Fed meeting. The Fed raised rates, but what was today’s focus?

Tom Lauricella: Yeah, this was not your typical Fed meeting where everything just revolves around what the Fed was going to do in terms of interest rates. With the emergence of this banking crisis a few weeks ago, things have really changed and that became a big part of the focus. It appeared to be a big part of the focus of the discussion at the Fed meeting as far as we could tell. And certainly, in the press conference, a lot of the questions from reporters to Fed Chair Powell were about the impact of the banking crisis, where things stand, and what that’s going to mean for the economy and monetary policy going forward.

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

Lauricella: The first thing for investors to remember, and we wrote about this, is that banking crises really aren’t just about the banks. Banks are a key, key cog in the economy, and the Fed knows this. I mean, it’s part of their mandate is to help make sure that the banking system is stable and functioning well. So, essentially, what the Fed told us is that they’re trying to assess the impact that this banking crisis will have on the economy. Fed Chair Powell went out of his way to repeatedly say that the banking system is sound. It’s stable. It seemed like they were really trying to send a clear message for people not to get all freaked out and panic and pull their money out of banks. That kind of crisis of confidence is something that the Fed really wants to avoid. But when it comes to the impact on the economy and monetary policy, this is where things get a lot squishier. There’s a lot more uncertainty in terms of what the impact will be and really what this means for the outlook for interest rates.

Hampton: Now, there were lots of questions about the outlook for interest-rate hikes. What was the message for investors?

Lauricella: The key message for investors today, as of today’s meeting, is that the Fed still sees the need to keep interest rates high. They signaled that they’re likely very near the end of the interest-rate cycle. Now, this is a difference from December and even just a few weeks back where it seemed like the Fed was clearly on a path to continued interest-rate hikes. The phrase that they were using was “ongoing interest-rate increases.” So, that message has changed significantly. The Fed no longer sees the need for ongoing interest-rate increases. We could still see another one, according to what the Fed is predicting, but the idea that it’s sort of open-ended at this point, that’s completely off the table. So, that’s a big change that we saw with this meeting.

Hampton: What does this mean for the overall economy?

Lauricella: Well, this is the question. And even Fed Chair Powell—he doesn’t have a crystal ball. It’s hard. Nobody really knows at this point. The question here is the degree to which banks are going to continue to tighten their lending standards, the degree to which banks are going to make it harder for individuals and companies to borrow. This is really critical. Lending is essentially the fuel that runs an economy, and if banks are cutting back on their lending, then that can really start to choke off economic growth. Fed Chair Powell said it was too early to tell at this point. The Fed keeps a very close watch on this kind of thing. He was directly asked, What does this mean for the prospects of 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 folks on Main Street can see if credit is tightening?

Lauricella: Yeah, this is a little tough. This is something that happens behind the scenes. The Fed reports data on this every week in terms of the amount of lending that’s going on, bank reserves. They periodically will publish reports on what they hear directly from lenders. But really it’s something that individuals will see when they go to take out a loan; it may start becoming harder to get a credit card. We had talked to one analyst who gave the example of somebody was looking to open a new dry-cleaning business. A couple of weeks ago, they might have gotten a loan. Today, when they go to their small or midsize lender, they might not get that loan unless they have perfect credit. It’s going to start to materialize bit by bit. This does take some time to play out. Morningstar’s chief economist, Preston Caldwell, notes that this is something that could play out over the next couple of quarters. It’s not something that will just—hopefully, anyway—shut everything off overnight. But this is something that plays out 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 were going to be able to get one and you can’t, that’s a big difference.

Hampton: Now, the focus of this series of meetings this week was on the banking sector, and that’s a big change from previous meetings. Where did the discussions center around inflation? I mean, is the Fed concerned about inflation this go-around?

Lauricella: They very much are, and that was sort of the thing that the Fed is having to balance here is that inflation is still running really hot. The most recent numbers we had was that inflation was at a 6% rate, according to the CPI. That’s way, way above the Fed’s target. The Fed is very much aware of this. They’re in this bind. They’re having to watch this banking crisis unfold. It’s unclear what the scope will be. But they also can’t keep their eye off the inflation ball because inflation is very hard to snuff out. So, if the Fed just changes tack completely and focuses only on supporting economic growth, there’s a risk that inflation could come back. And Morningstar’s Preston Caldwell has made this point—that if the Fed is actually successful in containing this crisis, they might actually have to do more work on keeping inflation down because the economy has been really strong. So, if this doesn’t tank the economy, it doesn’t slow it down, the Fed may have a lot more work to do. It’s a funny position that we’re in right now, very uncertain.

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

Lauricella: One of the key areas to watch is that there seems to be a difference of opinion between what the markets expect and what the Fed is telling us. The markets are actually very skeptical of the Fed’s forecasts. The market thinks the Fed is going to have to start cutting interest rates by the third quarter of this year. That may be a little bit premature. However, that’s something for investors to keep watch on: How does the market adjust to what’s happening out there? We’re going to have to be watching some of the more timely economic indicators to see whether things have started to turn out there, whether we start to see unemployment claims starting to rise, these bank lending statistics. There’s a lot to watch out there. It’s not the usual focus. It’s not just the stock market. Investors really need to be paying attention to some of these other things that aren’t usually what they’re watching, and a lot of this is in 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 is going to be on top of it. Thanks, Tom, for your time today.

Lauricella: Glad to be here. Thanks.

Hampton: Subscribe to the Smart Investor newsletter. You can catch up on the weekly rundown of Morningstar’s take on big market trends and investment opportunities. I’m Ivanna Hampton, a senior multimedia editor at Morningstar.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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