The Federal Reserve raised interest rates last week for the first time since July 2023, a move that was widely expected by markets. Updated projections from Fed policymakers currently point to one additional rate hike before the end of the year, although those projections can change as new economic data emerges.
One of the more notable signals came from Fed Chair Warsh, who said policymakers had “removed a dose of accommodation.” That language suggests the Fed still views monetary policy as somewhat supportive of economic growth and believes it has room to raise rates further if inflation remains a concern.
Energy Prices Add to the Inflation Picture
One of the biggest variables facing the Fed may be largely outside its control: energy prices.
Both gasoline and diesel prices have increased significantly. While gasoline prices are highly visible to consumers, diesel can have an even broader impact on inflation because of its role throughout the economy. Diesel powers farm equipment, transportation, manufacturing and construction. As those costs rise, businesses throughout the supply chain may eventually pass some of them along to consumers.
That creates a challenge for monetary policy. The Fed cannot produce more oil, increase refining capacity or resolve geopolitical conflicts affecting global energy markets. What it can influence is demand. Higher interest rates can slow certain types of spending and investment, potentially reducing some pressure on energy prices.
The reverse is also possible. If geopolitical tensions ease and energy prices decline meaningfully, the inflation outlook could improve relatively quickly. In that scenario, another rate hike may prove unnecessary, and a significant enough improvement in inflation could eventually bring rate cuts back into the conversation.
What Higher Rates Could Mean for Investors
For investors, it is important to remember that rising interest rates do not automatically translate into falling stock prices.
Goldman Sachs examined Fed hiking cycles going back to 1988 and found that the S&P 500 gained an average of approximately 9% during the 12 months following the beginning of a hiking cycle. The major exception was 2022, when inflation reached roughly 9% and the Fed was forced to raise rates aggressively over a relatively short period.
The distinction may be less about whether rates are rising and more about the speed and magnitude of the Fed's response. Gradual rate increases against the backdrop of a healthy economy are very different from aggressive tightening intended to bring runaway inflation under control.
For now, the Fed has taken another step toward tighter monetary policy. While markets will be watching closely for clues about the next move, global energy markets, and diesel prices in particular, may provide equally important signals about where inflation, interest rates and markets could be headed.
Often quoted in major national media, Adam is a Chartered Financial Analyst (CFA®), a CERTIFIED FINANCIAL PLANNER™ (CFP®), and has been included on the Forbes NextGen Best-in-State Wealth Advisors 2019 list. He is a member of the CFA Society of Los Angeles and the CFA Institute. Adam helps establish asset allocation strategy as a member of the EP Wealth Investment Committee, which supports all EP Wealth Advisors and their clients. The Committee’s top-down approach to portfolio construction begins with an outlook on the economy’s likely direction, followed by the implications for different economic sectors and asset classes. This culminates in strategic selection of the individual stocks, bonds, mutual funds or other investments deemed most appropriate for each individual client’s portfolio.
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Video Transcript:
Adam Phillips:
Hi, everyone.
The big story for markets last week was the Federal Reserve, which raised interest rates for the first time since July of 2023.
The move itself was widely expected. And based on the Fed’s updated projections—the so-called dot plot—policymakers currently see one more rate hike before the end of the year.
Now, the dot plot is not a promise. It’s simply a snapshot of where Fed officials think rates are headed based on the information they have today.
And right now, that distinction is especially important. One comment from Chair Warsh’s press conference caught my attention. He said the Fed had “removed a dose of accommodation.”
For those of us who probably spend too much time analyzing every word that comes out of the Fed, I think that wording is meaningful.
It suggests the Fed still views monetary policy as somewhat accommodative. In other words, they don’t believe interest rates are really putting the brakes on economic growth yet.
And if that’s the case, they believe they have room to raise rates further if inflation requires it. The question, of course, is whether it will. And I think that’s where this gets much more interesting.
Because one of the biggest inflation risks today is coming from something the Federal Reserve has virtually no control over: energy.
We’ve seen significant increases in both gasoline and diesel prices. And while everyone notices gasoline because we see the price every time we pull into a gas station, I’d argue diesel is just as important—if not more important—to watch from an inflation perspective.
That’s because diesel works its way through the entire economy. It powers farm equipment. It moves goods across the country. It’s used throughout manufacturing and construction. So when diesel prices rise, businesses throughout the supply chain face higher costs.
And eventually, some of those costs can find their way to consumers. That means the inflation question over the next several months may not simply be what’s showing up in today’s CPI report. It may increasingly be what’s already working its way through the pipeline.
And this highlights just how difficult the Fed’s job is right now. The Fed can’t produce more oil. It can’t increase refining capacity. And it certainly can’t resolve geopolitical conflicts in the Middle East or between Russia and Ukraine. What it can do is influence demand.
By raising interest rates and making financial conditions tighter, the Fed can slow certain types of spending and investment. If demand cools enough, that can help take some pressure off energy prices—or at least keep demand from making the problem worse.
But think about the other side of this. If geopolitical tensions were to ease and energy prices fell significantly, the inflation outlook could change pretty quickly.
Suddenly, that additional rate hike currently showing up in the Fed’s projections might not be necessary. And if inflation improved enough, eventually we could even find ourselves talking about rate cuts again.
That’s why I wouldn’t get overly focused on whether the Fed hikes exactly one more time this year. Nobody knows.
The bigger point is that the path of interest rates from here is going to depend heavily on the inflation data—and right now, a meaningful part of that story is being written in global energy markets rather than in Washington.
Finally, what does all of this mean for investors? It’s worth remembering that rising interest rates do not automatically mean falling stock prices.
Goldman Sachs looked at Fed hiking cycles going back to 1988 and found that, on average, the S&P 500 gained about 9% over the 12 months following the beginning of a hiking cycle.
The notable exception was 2022. And I think that exception tells us something important.
In 2022, inflation had climbed to its highest level in roughly 40 years, with CPI eventually reaching about 9%. The Fed had fallen behind inflation and was forced to raise rates very aggressively in a relatively short period of time.
Markets struggled. So perhaps the lesson from history isn’t simply that higher rates are good or bad for stocks. It’s that the speed and magnitude of the Fed’s response matter.
A gradual adjustment in interest rates against the backdrop of a healthy economy is very different from the Fed having to slam on the brakes because inflation has gotten out of control.
For now, the Fed has taken another step toward tighter policy. We’ll certainly be watching what they say about the next one. But I’d keep just as close an eye on what happens with energy—particularly diesel—because that may ultimately have a lot to say about where inflation, interest rates, and markets go from here.
Have a great week.
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