Did the Fed Just Give an All-Clear to the Stock Market?

The stock market moved sharply higher on Wednesday, with only a brief hiccup in the hour surrounding the latest decision from the Federal Reserve's monetary policy committee. Stocks briefly gave up most of their substantial gains from earlier in the session, but by the close, major indexes had jumped to their best levels of the day. The Nasdaq Composite (^IXIC -0.64%) powered higher by the greatest amount, but the Dow Jones Industrial Average (^DJI -0.98%) and S&P 500 (^GSPC -0.46%) also had large advances.

Data source: Yahoo! Finance.

It took some time for investors to parse through the impact of the Fed's latest decision. As expected, the information that the central bank offered went far beyond its immediate decision and what the Fed believes has implications for a wide swath of the financial markets.

Rates are finally rising

The headline of the day was that the Federal Reserve agreed to raise its short-term Federal Funds rate by a quarter percentage point. That puts the new range for the benchmark at 0.25% to 0.5 %. It was the first time since late 2018 that the Fed had increased rates, ending a cycle of easing that began in July 2019 and ended with the pandemic-driven move to slash rates in March 2020 to nearly 0% to support the floundering global economy.

More importantly, though, the central bank shared the views of its members on what they believe will happen with key economic indicators over the next several years. Policymakers believe that inflation will remain at heightened levels through 2022, with estimates of price rises of about 4.3%. A gradual decline to 2.7% in 2023 and 2.3% in 2024 should help maintain the Fed's longer-term target of 2%.

Image source: Getty Images.

Meanwhile, economic growth should persist. The U.S. economy won't be able to sustain its 5.6% growth rate from 2021, but 2022 gross domestic product (GDP) increases of 2.8% indicate a solid recovery. Fed policymakers anticipate 2.2% GDP growth in 2023, 2% in 2024, and 1.8% over the longer run.

Are more hikes coming?

Fed policymakers were unanimous in expecting a lot more tightening ahead, although just how many rate hikes they anticipate differed among members. Year-end projections suggested at least four more rate increases from here, with most looking for six. By 2023, Fed members believe the Fed Funds rate will be firmly between 2% and 3.75%, critically indicating that a move above the perceived 2% neutral policy level will be necessary to control inflation.

Judging from the distribution of gains in the market, investors aren't afraid of the potential impact on the economy. The largest percentage advances came from consumer discretionary stocks, technology, and financial stocks, suggesting that both consumers and businesses are likely to maintain their spending levels even in the face of higher borrowing costs. Declines in energy and utilities stocks reflected higher rates as well as hope that the geopolitical environment will become less heated.

Long-term investors haven't seen a major rate-tightening cycle in a while, but the strategy of finding great companies that can ride the ups and downs of the economy still works well. Investors can expect stocks to remain volatile in the near term, but greater certainty about how the Fed intends to fight the inflationary threat should give investors some solace as they position their portfolios for the rest of 2022.