Fed continues aggressive fight against inflation
The Federal Reserve raised its target interest rate by 75 basis points to a range of 3.00% to 3.25% following the two-day Federal Open Market Committee (FOMC) meeting. The Fed remains “strongly committed to returning inflation to its 2.0% objective.”
The so-called “dot plot” of new projections from Fed officials showed the fed funds rate rising to 4.40% by the end of this year before topping out at 4.60% in 2023. That implies another 75-basis point hike in November, followed by a 50-point increase in December.
The post-meeting statement said “recent indicators point to modest growth in spending and production,” though rising interest rates are expected to slow economic growth. The committee’s quarterly economic projections showed it expects economic growth slowing to 0.2% by the end of this year before rising to 1.2% in 2023. The unemployment rate is projected to rise to 3.8% this year and 4.4% in 2023. Inflation is seen slowly returning to the Fed’s 2% target in 2025. Rate cuts are not foreseen until 2024.
In his post-meeting press conference, Fed Chair Jerome Powell noted “price pressures remain evident” and said the Fed will continue to take “forceful and rapid” steps the moderate demand and lower inflation. “We’re committed to a restrictive level and getting there pretty quickly,” he said. The aggressive stance to fight inflation will slow economic activity and Powell said achieving a soft landing would be “very challenging.” Powell said policymakers are uncertain if the tightening monetary policy will eventually lead to recession.
Powell warned against reversing course and lowering interest rates too quickly – even though the aggressive monetary policy tightening will slow economic activity. He noted, “The historical record cautions strongly against prematurely loosening policy.”
Confluence Investment Management says this rate hike was “historic,” as it “lifted the policy rate above the previous cycle’s peak for the first time since 1981. The milestone possibly reflects the central bank’s confidence in financial market conditions. The previous two economic downturns exposed the weaknesses in the financial system and forced the Fed to develop policy tools designed to prevent a crisis. Therefore, we may be heading into a new finance regime in which the Federal Reserve raises interest rates and maintains those rates for much longer. If so, the tech sector’s dominance in the S&P 500 is likely over. However, the financial services industry could be on the ascent.”
“The Fed’s new policy tools will be tested as the central bank ramps its balance sheet reduction and rate hikes over the next few months. Quantitative tightening is expected to cause financial strain as traders struggle to get deals done. The Bloomberg U.S. Government Securities Liquidity Index, a gauge of deviations in yield compared to a fair value model, dropped to its lowest level since March 2020. The deterioration in the index suggests that traders find it more challenging to exchange treasuries for cash and vice versa. If the problem worsens, the Fed will be forced to intervene. Although the financial system is withstanding monetary tightening now, we are still not sure that a financial mishap will not take place in the future. In the event of a blowup in the financial system, we expect the Fed to become more accommodative in its rate policy. As a result, we believe that the Fed could pause or cut rates by mid-2023 if financial conditions deteriorate significantly.”
