There’s an alarming trend that has historically occurred each time the Federal Reserve has raised rates significantly: Something always breaks. While the recent banking mini-crisis appears well-contained, the risk of further turmoil increases with each subsequent rate hike, and investors should brace their portfolios to minimize vulnerability to these macro-driven threats.

History of Fed Funds rate hikes and subsequent crisis events
Effective Federal Funds rate, 1966–present

Graph indicating crisis events in relation to rate hikes from 1966 to present.

Source: Federal Reserve, Bloomberg, Principal Asset Management. Data as of March 24, 2023.

In the space of 12 months, the Federal Reserve (Fed) has raised policy rates by 475 basis points, taking the Fed Funds rate up to 4.75%-5.00%. Not only has this been the most aggressive pace of Fed tightening since 1980, policy rates are now the highest since 2007, just before the Great Financial Crisis. Historically, whenever the Fed has raised rates significantly, it has resulted in some type of crisis.

In the current cycle, there have been several mini-crises including the UK LDI crisis last October which threatened the UK pension system and, more recently, the collapse of two U.S. banks. Both triggered sharp market turmoil but were rapidly contained by policymaker liquidity intervention, enabling central banks to continue raising policy rates. Unfortunately, each additional rate hike increases economic and financial pressures, raising the chances of further crises.

While today’s Fed could respond by cutting policy rates, with inflation still elevated, an aggressive Fed response may be delayed. Even then, by the time the Fed pivots, historically, the damage is usually done, and risk assets continue to struggle even as rates fall.

Economic activity has been resilient, and unemployment sits near historic lows, so it’s possible markets could shrug off any additional turmoil during this hiking cycle. However, investors should adjust their exposures to help minimize vulnerability to macro-driven threats—just in case history repeats itself. Again.

Disclosure

Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results and should not be relied upon to make an investment decision.

The information presented has been derived from sources believed to be accurate; however, we do not independently verify or guarantee its accuracy or validity. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, and does not take account of any investor’s investment objectives or financial situation and should not be construed as specific investment advice, a recommendation, or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding an investment or the markets in general. The opinions and predictions expressed are subject to change without prior notice.

Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc.

Principal Asset Management leads global asset management at Principal.®

For Public Distribution in the U.S. For Institutional, Professional, Qualified and/or Wholesale Investor Use only in other permitted jurisdictions as defined by local laws and regulations.

© 2023, Principal Financial Services, Inc. Principal Asset ManagementSM is a trade name of Principal Global Investors, LLC. Principal®, Principal Financial Group®, Principal Asset Management, and Principal and the logomark design are registered trademarks and service marks of Principal Financial Services, Inc., a Principal Financial Group company, in various countries around the world and may be used only with the permission of Principal Financial Services, Inc.

2811938