US Funds Sector Review – Will Interest Rates Keep Climbing in 2023?

Recently, there have been increasing indications that the US Federal Reserve (Fed) will continue to raise interest rates throughout 2023. In fact, since March 2022, interest rates have risen eight times, including four hikes of 0.75%, marking the quickest rate-rising cycle since the 1980s. The reason behind the rate hikes is to tame inflation and bring it back down to its 2% target range, which can be both positive and negative for investors and the overall economy.

Why Have US Interest Rates Risen?

Central banks typically raise interest rates to cool down an overheating economy and reduce demand. It increases the reward for savers looking to earn interest on their cash and makes it more expensive for consumers and businesses to borrow money. The Fed’s goal is to carefully balance slowing the economy to tame inflation with the risk of slowing growth to the point of tipping the economy into a recession.

However, inflation is a tricky beast to tame. Recently, Fed Chairman Jerome Powell warned that the path to decreasing US inflation would probably be bumpy. The Fed’s decision to tighten monetary policy and increase interest rates is starting to affect demand. Inflation peaked at 9.1% in June 2022 and had decreased seven months since then to 6.4% by the end of January.

Is Inflation Stickier Than First Perceived?

The consecutive falls in inflation sparked the belief that the Fed had inflation under control and headed in the right direction. The expectation was that the Fed could begin to hold rates as they are and even potentially cut rates later in the year. However, strong economic data suggests that inflation will persist more than the market hoped.

Although headline inflation has continued to fall, it came in above market expectations at 6.4% compared to an expected fall of 6.2%. This was coupled with a seemingly robust labor market that created 517,000 new jobs in January, well above market expectations of 185,000, as the unemployment rate fell to 3.4%. As a result, investors are concerned that the hot labor market will cause inflation to stick around for longer, leading the Fed to continue its rate-hiking cycle.

Higher Interest Rates and the US Housing Market

Rising interest rates don’t only affect stock markets; they also tend to slow down the housing market. This is because higher interest rates mean higher mortgage repayments, ultimately reducing the amount homeowners can spend elsewhere. Again, this helps slow the economy and lower inflation.

However, the US housing market is primarily dominated by long-term fixed-rate mortgages. This means most homeowners aren’t seeing their mortgage repayments increase and can continue spending the same amount on goods and services. Nonetheless, the housing market is slowing down, partly due to the higher repayments associated with entering new mortgages or refinancing current ones. In addition, issuers’ interest rates for new mortgages have increased significantly over the last 12 months. Thus while homeowners can still afford to pay their current mortgage, if they were to move house and borrow the same amount to finance the move, their mortgage repayments would increase, further exacerbating the housing market slowdown.

Related Facts

• The Fed has hinted that it may speed up the pace of interest rate hikes in response to stronger-than-expected inflation and the labor market’s robustness.
• The Fed’s interest rate hikes will likely cause the US dollar to strengthen and make foreign investments more appealing.
• Investors should brace for more volatility, higher borrowing costs, and a potential slowdown in economic growth.

Key Takeaway

Given rising inflation, the Fed’s rate hiking cycle may continue throughout 2023, and it remains to be seen whether the economy will slow down too much. Moreover, whether or not interest rates keep climbing, investors should maintain a diversified portfolio to mitigate market volatility and capitalize on potential opportunities.

Conclusion

The US Federal Reserve’s ongoing interest rate hikes may be good and bad news for investors, depending on their investments’ nature. While higher interest rates increase the rewards for savers, they also make it more expensive for borrowers, which could result in a slowdown. However, inflation shows increasing signs of stubbornness, and the hot labor market could cause the Fed to continue its rate-hiking path, leading to more volatility in the markets.