Fed raises interest rates by three-quarters, biggest increase in 28 years

The Federal Reserve raised the benchmark interest rate by 75 basis points on Wednesday, the biggest rate hike since November 1994, as part of efforts to rein in soaring inflation.

Federal Open Market Committee (FOMC) officials have agreed to increase the federal funds target range to 1.5% and 1.75%. This is the rate banks charge each other for overnight borrowing, affecting consumer borrowing, such as credit cards and home equity loans.

Prior to the latest headline inflation reading, the Fed’s forecast had forecast a rate hike of 50 basis points in June. Investors had expected this level, but a scorching consumer price index (CPI) prompted the market to change its expectations and forecast a more hawkish central bank.

The Fed raised interest rates by 25 basis points in March, marking the first increase since 2018. Additionally, rates were raised by half a percentage point last month.

Looking ahead to the FOMC’s interest rate projections, the Fed is forecasting 3.4% at the end of 2022, down from 1.9% in the March projection. He also expects 3.8% next year.

The Fed raised its inflation forecast for this year from 4.3% in the March projections to 5.2%. The central bank sees inflation slowing to 2.6% next year.

On the GDP front, the Fed expects growth to slow to 1.7% this year from the previous forecast of 2.8%.

“Overall economic activity appears to have recovered after declining slightly in the first quarter,” read the revised FOMC statement. “Job gains have been robust in recent months and the unemployment rate has remained low. Inflation remains elevated, reflecting pandemic-related supply and demand imbalances, rising energy prices and broader price pressures.

“Russia’s invasion of Ukraine is causing enormous human and economic hardship. The invasion and related events create additional upward pressure on inflation and weigh on global economic activity. Additionally, COVID-related lockdowns in China are likely to worsen supply chain disruptions. The Committee pays close attention to inflation risks.

Financial markets pared some of their gains. The Dow Jones Industrial Average turned negative after the announcement. The S&P 500 rose 0.3%, while the Nasdaq Composite Index remained up about 1%.

The US Treasury market was mostly in the red, with the benchmark 10-year yield down 6.2 basis points to 3.421%.

From controlled burning to forest fire

The central bank has been under pressure to rein in high inflation for four decades by being more aggressive in tightening monetary policy and resorting to huge rate hikes. At the same time, the Fed must avoid a brutal crash, ensuring that the United States does not slide into a recession.

Powell and the FOMC are entrenched in a juggling act to balance economic growth and rein in inflation. A chorus of economic commentators doubt the Fed can fight inflation and support post-pandemic economic expansion.

The situation comes down to the Fed being unable to admit the problem in the first place, says Nancy Tengler, CEO and CIO of Laffer Tengler Investments.

Since last year, policymakers “share a stubborn refusal to admit the problem,” she said in a research note. “The chaos resulting from their actions – and make no mistake, these bad policies straddle both sides – remains unrecognized, unreviewed, unresolved, doomed to repeat itself.”

Ed Yardeni, chairman and chief investment strategist, essentially echoed that sentiment in a note Wednesday, writing that the Fed has been behind the curve, “waking up” in the process.

“Perhaps the most important similarity between the 1970s and recent events is the Fed’s lame response to the wage-price-rent spiral. The Fed was well behind the inflation curve for most of the 1970s and is now again,” Yardeni noted.

Today, the US economy faces a trade-off: beat inflation with a recession or deal with soaring prices and maintain stagnant growth.

“[A] A more accelerated Fed hike cycle should ultimately help keep inflationary pressures under control, but it will make it harder to swing the needle between lower inflation and a recession,” Deutsche Bank said in a note. tuesday. “We continue to anticipate that bringing inflation back to target will require a significant impact on demand and an increase in the unemployment rate, which is historically the case.”

Substantial rate hikes are increasingly expected to dampen business activity and spending, while leading to larger job losses.

But everything the Fed does going forward will be data-driven, which has been the modus operandi before the tightening cycle began, says Robert R. Johnson, CEO of Economic Index Associates and Professor, Heider College of Business, Creighton University.

“Let the Federal Reserve raise rates in a very measured way and it’s possible we can achieve a soft landing for the economy,” Johnson told The Epoch Times. “Reckless movements as some call for would preclude any possibility of a soft landing.”

He expects the year-end interest rate to be closer to 3.75% to 4%.

According to Jan Szilagyi, CEO of Toggle, an AI-based research investment firm with quantitative analysis, Powell and the rate-setting committee had helped financial markets prepare for an environment of slower economic growth by raising rates by 50 basis points until pricing pressures ease.

“A move to 75 basis points would definitely shake that balance,” Szilagyi wrote in a research note.

Whether it’s 50 or 75 basis points, the main question now is whether the Fed can avoid a recession, Tangler noted.

“We expected the economy to slow down in 2022 and have adjusted strategies and global allocations accordingly. And I have been in camp for a short and shallow recession in 2023,” she said .

At this point, some argue that the Fed may not be doing enough to calm price inflation since real interest rates are still negative. But what else can we do?

The Fed has other tools in its arsenal, Szilagyi notes. One could be to raise borrowing costs for longer-maturity loans by signaling a faster pace of rate increases or a higher end point.

About this recession

Wall Street seems to be divided on the chances of a recession. Many financial institutions and analysts have placed bets at 50%, while others believe there is a decent chance that the US economy will experience a soft landing.

The May of the Fed Bank of Philadelphia investigation of 34 professional forecasts revealed that GDP growth in the second quarter is expected to be 2.3%, down from the previous estimate of 4.2%.

The Fed Bank of Atlanta GDPNow Model forecasts 0% growth over the period from April to June.

But could a recession already be here? That wouldn’t be surprising, said Peter Boockvar, chief investment officer at Bleakley Advisory Group.

“I wouldn’t be surprised if it started in the third quarter of this year,” he said. Told CNBC Friday. “You can tell we’re in the middle of that right now, in the start-up phase. Only in retrospect will we know for sure, but that shouldn’t surprise us at this point.

In the first quarter, the US economy contracted at a rate of 1.5%.

The next two-day policy meeting of the FOMC will take place on July 26-27.

According to FedWatch CME Toolthe market expects a three-quarter point rate hike next month.

Follow

Andrew Moran covers business, economics and finance. He was a writer and journalist for over a decade in Toronto, with bylines on Liberty Nation, Digital Journal and Career Addict. He is also the author of “The War on Cash”.

Comments are closed.