ETFs React To First Fed Rate Hike Since 2018

The Fed boosted rates, but stock ETFs rallied.

sumit
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Senior ETF Analyst
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Reviewed by: Sumit Roy
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Edited by: Sumit Roy

“Sell the rumor, buy the news” best explains the action in ETFs in the aftermath of the Federal Reserve’s highly anticipated decision to hike interest rates for the first time since 2018. The benchmark federal funds rate now stands at 0.25-0.5%, up from 0-0.25%.  

It doesn’t hurt that the central bank signaled its intent to raise rates well ahead of its actual move. But it’s still impressive that equity ETFs like the SPDR S&P 500 ETF Trust (SPY) were able to rally so much in the face of what many considered to be a notably hawkish pivot by the Fed. 

The median Fed official now expects to hike rates in each of the next six meetings, bringing the Fed funds rate up to 1.9%. If the projections are right, that would be followed by another three hikes in 2023, bringing the rate up to 2.75%.  

Though many investors were anticipating a flurry of rate hikes this year, it was jarring to see the Fed pivot so aggressively toward combating inflation. The Fed’s last forecast put out in December called for only three rate hikes this year and another three hikes next year, bringing the fed funds rate up to 1.6%. 

The new projections are more than a full percentage point higher. Perhaps what’s made investors especially anxious is that the Fed downplayed the risks from the Russia-Ukraine war and related commodity price shocks on economic growth. Fed Chair Powell emphasized how strong the economy was and considered risks of a recession in the next year as “not particularly elevated.” 

It’s a fair point, considering the unemployment rate has nearly dropped to prepandemic lows; job growth remains robust; and GDP is poised to grow well above what economists consider a normal rate. Nevertheless, the Fed’s new hawkish tone reminded investors that this is a very different rate-hiking cycle than the last one. 

With inflation at 40-year highs, the Fed’s has much less of an ability to support the economy in case of an unexpected downturn. As Powell reiterated multiple times, inflation must be dealt with. The hope is that economic growth remains robust, enabling the Fed to press on its monetary brakes and bring inflation down without sparking a recession—a “soft landing.” 

But in an indication of just how difficult the central bank’s job will be, parts of the Treasury yield curve inverted, while other parts narrowed to uncomfortably thin levels after the Fed meeting. The yield on the five-year Treasury briefly surpassed that of the 10-year, and the difference between the 10-year and two-year fell to 22 basis points, the smallest gap between the two since February 2020. 

 

10-Year to 5-Year Spread 


Inverted yield curves, where short-term rates are higher than long-term rates, are seen as signs of a potential recession.  

The reluctance of long-term rates to move up could be viewed from multiple angles. Maybe the market believes that inflation will come down naturally as supply chain issues and commodity price pressure abate. Or maybe the market thinks the Fed will induce a significant economic slowdown, which would also bring inflation down, though not in the way most people want to see it come down. 

The same market indicators can be interpreted in different ways, but most people would agree that an inverted yield curve, especially in the 10’s to 2’s part of the curve, is a worrying omen for the economy and markets.

 

10-Year to 2-Year Spread 

 

Buying The News 

Given all the interest rate uncertainty, it’s understandable that markets initially sold off after the Fed’s decision. But they quickly roared back as investors “bought the news” and reasoned that the central bank’s forecast for rate hikes was largely in line with what most investors were expecting. 

Many parts of the stock market were also deeply oversold, such as the ARKK Innovation ETF (ARKK), which was down 67% from its highs of a year ago at its low point on Monday. ARKK jumped 10.4% on Wednesday. 

Even the broader Vanguard Information Technology ETF (VGT) was down 21% from its highs on Monday. It regained 3.7% on Wednesday. The aforementioned SPY climbed 2.2% after the Fed decision; at its worst point it was down around 13% from its highs. 

Meanwhile, bonds were mixed once investors had a chance to digest the Fed’s moves and commentary. The 30-year Treasury yield edged lower, while other parts of the curve edged up. It’s been a rough year for fixed income ETFs as bond prices adjust to the new, higher-inflation, higher-rate environment.  

The iShares Core U.S. Aggregate Bond ETF (AGG) is lower by 5.3% on a year-to-date basis. It eked out a 0.07% gain after the Fed rate decision. 

Investors will now closely monitor inflation, economic growth and geopolitical events to see whether the Fed is likely to ratchet up or down its pace of interest rate hikes. The range of outcomes for monetary policy has seldom been so wide.  

 

Follow Sumit Roy on Twitter @sumitroy2      

Sumit Roy is the senior ETF analyst for etf.com, where he has worked for 13 years. He creates a variety of content for the platform, including news articles, analysis pieces, videos and podcasts.

Before joining etf.com, Sumit was the managing editor and commodities analyst for Hard Assets Investor. In those roles, he was responsible for most of the operations of HAI, a website dedicated to education about commodities investing.

Though he still closely follows the commodities beat, Sumit covers a much broader assortment of topics for etf.com, with a particular focus on stock and bond exchange-traded funds.

He is the host of etf.com’s Talk ETFs, a popular video series that features weekly interviews with thought leaders in the ETF industry. Sumit is also co-host of Exchange Traded Fridays, etf.com’s weekly podcast series.

He lives in the San Francisco Bay Area, where he enjoys climbing the city’s steep hills, playing chess and snowboarding in Lake Tahoe.