Weekly Market Update: The Fed Plans to Increase Rates
Annnnd we’re back! Welcome to the weekly market update from Signature Wealth Management. I’m Brian Ransom, Research Director from Signature Wealth and here’s what happened in the market this week.
2021 ended the year with a bit of volatility. At the end of November, we experienced a 4% downturn followed by a quick recovery, a 3.3% downturn in December followed by a quick recovery, and most recently a 2% downturn on Wednesday. The final tally for 2021, however, was a 28.75% total return for the S&P 500.
In the news this week, the Omicron variant continues to spread but disease severity seems much less severe, which would be good for the market and the economy. Stocks did waver on the 5th, however, with rising interest rates on the 10-year yield. The sell off on the 5th also corresponded to an announcement from the Federal Reserve on possible rate increases in the Fed Funds rate in March.
So let’s spend a little time talking about what that means. The Fed Funds rate is the overnight lending rate between two banks. When two banks have excess reserves, they can effectively lend to each other at the overnight right to enhance liquidity. That overnight rate is set by the federal reserve and is known as the Fed Funds rate. Increases in the Fed Funds rate reduce the amount of borrowing in overnight lending, reducing the amount of money supply in the system. This is primarily used to combat inflation. The higher the Fed Funds Rate, the lower the amount of lending, the lower the money supply, and theoretically the lower the inflation.
Investors like to track the Fed funds rate, shown in blue here, because it does inevitably affect returns in the stock market shown in red. Typically, the fed will start increasing rates with a rapidly expanding economy to help slow down inflation. Sometimes this can lead to a business cycle contraction like we saw in 2001 and 2008, which is simultaneously followed by a stock market decline and a successive decrease in the fed funds rate from the federal reserve. In 2020, the stock market crashed due to the onset of the pandemic and the Federal Reserve was able to add liquidity back into the economy by lowering the Fed Funds rate to 0%.
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1.FactSet Research Systems. (n.d.). S&P 500 (Interactive Charts). Retrieved January 6, 2022, from FactSet Database.
2.FactSet Research Systems. (n.d.). S&P 500, Effective Federal Funds Rate (Interactive Charts). Retrieved January 5, 2022, from FactSet Database.
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