Fed raises rates by half a percentage point – the biggest hike in two decades – to fight inflation
WASHINGTON — The Federal Reserve raised its benchmark interest rate by half a percentage point on Wednesday, the most aggressive step yet in its fight against generational highs in inflation.
“Inflation is far too high and we understand the difficulties it is causing, we are moving quickly to bring it down,” Fed Chairman Jerome Powell said at a news conference he started. by saying you want to “speak directly to the American people”. He then noted the burden of inflation on low-income people, saying, “we are firmly committed to restoring price stability.”
This will likely mean, according to the president’s comments, several 50 basis point rate hikes to come, but nothing more aggressive than that.
Along with the rate hike, the central bank has signaled that it will begin to reduce assets held on its balance sheet by $9 trillion. The Fed had been buying bonds to keep interest rates low and money circulating in the economy, but soaring prices necessitated a drastic overhaul of monetary policy.
Markets were prepared for both moves, but they were nonetheless volatile throughout the year. Investors relied on the Fed as an active partner to keep markets functioning, but the surge in inflation necessitated tightening.
Wednesday’s rate hike will push the fed funds rate into a 0.75%-1% range, and current market prices push the rate up to 3%-3.25% by the end of the month. year, according to data from the CME group.
Stocks rose after the announcement while Treasury yields retreated from their previous highs.
Markets now expect the central bank to continue raising rates aggressively in the months ahead. Powell, only said 50 basis point moves “should be on the table in the next couple of meetings,” but he seemed to discount the likelihood of the Fed becoming more aggressive.
“Seventy-five basis points is not something the committee is actively considering,” Powell said, despite market prices that had tilted heavily toward the Fed’s hike of three-quarters of a percentage point in June.
“The U.S. economy is very strong and well positioned to handle tighter monetary policy,” he said, adding that he expected a “soft or rather soft” landing for the economy despite the tightening.
The plan outlined Wednesday will see the balance sheet reduction happen in phases, as the Fed will allow a capped level of proceeds from maturing bonds to roll over each month while reinvesting the rest. Starting June 1, the plan will see $30 billion in treasury bills and $17.5 billion in mortgage-backed securities. After three months, the cap on treasury bills will increase to $60 billion and $35 billion for mortgages.
These numbers were mostly in line with discussions from the last Fed meeting, as described in the session minutes, although some expected the cap increase to be more gradual.
Wednesday’s statement noted that economic activity “decline slightly in the first quarter” but noted that “household spending and business fixed investment remained strong.” Inflation “remains high,” the statement said.
Finally, the statement addressed the Covid outbreak in China and the government’s attempts to address the situation.
“In addition, the COVID-related lockdowns in China are likely to exacerbate supply chain disruptions. The Committee is very mindful of inflation risks,” the statement said.
“No surprises on our end,” said Collin Martin, bond strategist at Charles Schwab. “We’re a little less aggressive on our expectations than the markets. Do you think another 50 basis point hike in June looks likely. … We think inflation is close to peaking. If that’s showing any signs of peaking and declining later in the year, this gives the Fed a little leeway to slow down at such an aggressive pace.”
Although some members of the Federal Open Market Committee pushed for larger rate hikes, Wednesday’s decision received unanimous support.
The 50 basis point increase is the biggest hike the rate-setting FOMC has instituted since May 2000. At the time, the Fed was battling the excesses of the dotcom and dotcom-era era . This time, the circumstances are a little different.
As the pandemic crisis hit in early 2020, the Fed lowered its key funds rate to a range of 0% to 0.25% and instituted an aggressive bond-buying program that more than doubled its balance sheet at some $9 trillion. At the same time, Congress approved a series of bills that injected more than $5 trillion in tax expenditures into the economy.
These policy measures have come at a time when supply chains have become clogged and demand has increased. 12-month inflation rose 8.5% in March, according to the Bureau of Labor Statistics consumer price index
For months, Fed officials called the surge in inflation “transient” and then had to rethink that stance as the pressures did not let up.
For the first time in more than three years, the FOMC approved a 25 basis point hike in March, indicating that the funds rate could rise to just 1.9% this year. Since then, however, several statements from central bankers have pointed to a rate well beyond that. Wednesday’s decision marked the first time the Fed has raised rates in back-to-back meetings since June 2006.
Stocks fell throughout the year, with the Dow Jones Industrial Average falling nearly 9% and bond prices also falling sharply. The benchmark 10-year Treasury yield, which moves opposite to price, was around 3% on Wednesday, a level it hasn’t seen since late 2018.
The last time the Fed was this aggressive with rate hikes, it raised the funds rate to 6.5%, but was forced to pull back just seven months later. With the combination of an already ongoing recession and the terrorist attacks of September 11, 2001, the Fed quickly cut, eventually reducing the funds rate to 1% by mid-2003.
Some economists fear the Fed will face the same situation this time around – failing to act on inflation as it rose and then tightening in the face of slowing growth. GDP fell 1.4% in the first quarter, although it was held back by factors such as rising Covid cases and a slowdown in inventory build which is expected to ease throughout the month. ‘year.
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