'The Fed pushed until something broke, but it's still raising rates'

While most advisors may not have been surprised that the U.S. Federal Reserve hiked its policy interest rate by another 25 basis points yesterday to a range of 4.75% to 5%, it is ringing alarm bells for some.

“I’ve been concerned for quite awhile,” Allan Small, the senior investment advisor for Allan Small Financial Group with iA Private Wealth in Toronto told Wealth Professional after the announcement.

“The Fed has, for whatever reason, this mentality of pushing until something breaks – and we obviously saw something break in the last few weeks, and yet it still continues to raise its rates.”

Small said the Fed was expected to raise its rate by 50 basis points a couple of weeks ago, but after the collapse of Silicon Valley Bank (SVB) and Signature Bank, he felt it needed to show that things were still fine in the banking industry by raising it by at least 25 basis points – not just to fight inflation, but to send a positive message to the markets that the sector was fine.

In fact, the central bank’s announcement declared that “the U.S. banking system is sound and resilient” and that it planned to continue its course to achieve maximum employment and inflation at the rate of two percent over the long run. It expects to raise rates to the 5% to 5.25% in 2023 to achieve this goal, noting it will also continue to reduce its holdings of Treasury securities, agency debt and agency mortgage-backed securities.

Small, however, warned there is a danger the aggressive interest-rate increases have already gone too far, given they were significant contributors to the collapse of both SBB and Signature Bank.

“You could say their management didn’t make the right decisions, but whenever you raise rates eight or nine times in a span of 12 months, you’re asking for trouble,” he said, adding that while the Fed may be reacting to the strong labour market, that is the wrong indicator to follow since people are returning to work post-pandemic while all the other indicators are showing inflation retreating.

North of the border, Small felt the Bank of Canada pausing its rate hikes was the right thing to do as inflation is already slowing in Canada, though it could take a while yet to get to the desired levels of 2%. Given what’s happened in the banking industry, he said this is a good time for advisors to snap up bank stocks – both Canadian and American – since the core industry is solid, with most Canadian banks yielding 6% to 6.5% dividends.

Ryan Gubic, a certified financial planner and founder of MRG Wealth Management in Calgary, noted that the Federal Reserve was slowing its rate hikes and making them more contingent on how the economy responds, even while it continues to fight inflation. 

He noted the Bank of Canada was doing the same, by taking a recent pause, but he expected it might hike its rate another 25 basis points in the next couple of months, given the Fed’s move. But, he added, “both the Federal Reserve and Bank of Canada alluded to the fact that they’re getting cautious with future interest rate increases.”

Gubic noted the S&P 500 only had a minor drop after the Fed's announcement yesterday, so the markets were not making a major shift.

He didn't expect the Fed's 0.25 per cent increase to have much impact on clients' investments in the short term. However, recession fears are growing, which could impact many people. Gubic noted that, while the ripples of the SVB collapse should not be ignored, the banking sector in both Canada and the U.S. appears healthy.