By Andrew Moran
The Federal Reserve raised interest rates by the most since 2000 on May 4 as part of efforts to fight 40-year-high inflation.
Officials serving on the Federal Open Market Committee (FOMC) agreed to increase the benchmark fed funds rate by 50 basis points, bringing it to a target range of 0.75 percent to 1 percent. The central bank’s decision was in line with market expectations.
“There is a broad sense on the committee that additional 50-basis-point increases should be on the table at the next couple of meetings,” Fed Chairman Jerome Powell announced at a post-meeting press conference.
The Fed will also begin trimming its nearly $9 trillion balance sheet, confirming that it will start selling $47.5 billion in assets per month. After three months, the central bank would increase asset reductions to $95 billion per month, a measure that might reduce liquidity from money markets for several years.
In a FOMC statement, the Fed acknowledged that it is concerned about elevated broad-based inflation pressures.
“Although overall economic activity edged down in the first quarter, household spending and business fixed investment remained strong. Job gains have been robust in recent months, and the unemployment rate has declined substantially. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures,” the FOMC said.
“The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The implications for the U.S. economy are highly uncertain. The invasion and related events are creating additional upward pressure on inflation and are likely to weigh on economic activity. In addition, COVID-related lockdowns in China are likely to exacerbate supply chain disruptions. The Committee is highly attentive to inflation risks.”
The Fed’s decisions influence borrowing costs, which is why interest rates are very important. When rates are higher, it might discourage more consumers from taking out a mortgage or applying for an automobile loan.
Investors may also be less aggressive, especially following a period of historically low interest rates; however, it could encourage more households to save.
“When the Fed raises or reduces the cost of money, it affects interest rates across the board,” says Greg McBride, CFA, Bankrate chief financial analyst. “One way or another, it’s going to impact savers and borrowers.”
During the press conference, Powell ruled out a 75-basis-point boost at subsequent FOMC meetings, which dashed market speculation. Stocks surged as a result, with the Dow Jones Industrial Average jumping over 900 points, or 2.8 percent. The S&P 500 rose 3 percent, while the Nasdaq Composite gained 3.2 percent.
“Inflation is much too high, and we understand the hardship it is causing,” Powell said in his press conference opening remarks.
“And we’re moving expeditiously to bring it back down. We have both the tools we need and the resolve that it will take to restore price stability on behalf of American families and businesses.”
Powell voiced confidence in the Fed’s ability to contain inflation without triggering a recession.
“I think we have a good chance to have a soft or softish landing,” he said.
A Neutral Rate Is Coming?
In recent weeks, central bank officials had signaled they were going to be more aggressive in tightening monetary policy to fight inflation. On multiple occasions, Powell noted that he wants to bring the benchmark rate to neutral territory—a rate that neither stimulates nor limits economic growth—which the institution’s latest quarterly economic forecast has pegged at 2.4 percent.
“It may be that the actual [inflation] peak was in March, but we don’t know that, so we’re not going to count on it,” he said at an International Monetary Fund (IMF) event in April. “We’re really going to be raising rates and getting expeditiously to levels that are more neutral and then that are actually tight … if that turns out to be appropriate once we get there.”
Other FOMC members have echoed Powell’s sentiment about reaching a neutral rate by the year’s end.
“I see an expeditious march to neutral by the end of the year as a prudent path,” San Francisco Fed Bank President Mary Daly said last month.
Fed Bank of Chicago President Charles Evans told the Economic Club of New York late last month that the rate-setting FOMC will “probably” venture beyond neutral.
“On the way to December, you’d be looking for any confirmation of the storyline,” Evans said. “It could be that short-term neutral is actually lower, and that by the time we get to 2.5, it’s actually contractionary for a variety of reasons. It could go the other way too,” he said.
That said, the 2.4 percent figure has led to disagreement among some economists, who purport that a neutral rate is a lot higher when the central bank’s preferred inflation gauge—the personal consumption expenditure (PCE) price index—is running north of 5 percent.
According to the CME FedWatch Tool, most of the market is penciling in another half-point rate hike next month.
‘A Delicate Balancing Act’
With the first-quarter GDP contracting, and market analysts expecting sluggish growth in the coming months, it is going to be “a delicate balancing act” for the Fed, said John Leer, Morning Consult chief economist.
Powell has stated that his goal is to accomplish a soft landing: lowering inflation, supporting economic growth, and maintaining a strong labor market.
“The Federal Reserve is in a tough spot right now as it navigates elevated risks of a recession. They want to raise rates high enough and fast enough to curb inflation, but they don’t want to tip the economy into a recession. It’s a delicate balancing act that’s sure to test Fed policy,” Leer wrote in a note.
Whatever happens, Ken Mahoney, the CEO and president of Mahoney Asset Management, believes the Fed has “lost credibility overall.” Many experts, including Mahoney, have pointed to last year’s insistence by the Fed that inflation was “transitory.”
According to Mahoney, the best opportunity to raise interest rates by 50 basis points was last year, when the GDP expanded by more than 5 percent.
“Instead, we are here raising rates when first-quarter GDP was negative and inflation is clearly here to stay,” Mahoney told The Epoch Times. “It feels like there’s a bidding war with the Fed governors.
“One says four rate hikes, another says eight, another says I’m more hawkish than you, I say 12. I think at the end of the day, it will be three or four because the economy couldn’t withstand more than that in this case, and the market would buckle further.”
Robert R. Johnson, chair and CEO of Economic Index Associates, disagrees with pundits who have conveyed their disapproval of the Fed’s actions.
“Based on past experience, pundits have expressed little confidence that the Fed will be able to get inflation under control and orchestrate a soft landing for the economy,” Johnson, a professor of finance at Creighton University’s Heider College of Business, told The Epoch Times.
“I disagree and am in agreement with Warren Buffett, who, on Saturday, called Jay Powell ‘a hero’ whose aggressive action avoided an economic disaster.”
Treasury Secretary Janet Yellen, who served one term as head of the central bank, asserted that the Fed must be “skillful” and “also lucky” to facilitate a soft landing.
Speaking at a Wall Street Journal CEO Council conference on May 4, Yellen reaffirmed her confidence in the post-pandemic U.S. economy, but conceded that inflation remains a problem.
On the data front, all eyes will be on the May 6 jobs report for April and next week’s April consumer price index (CPI) numbers.
Economists expect that the U.S. economy created 394,000 new jobs last month.
Meanwhile, Americans could be losing confidence in the central bank, which is more than a century old.
A new Gallup survey found that only 43 percent have a “great deal” or “fair amount” of confidence in Powell, down from 55 percent last year. This is below his term average of 50 percent, but it’s in the same ballpark as his two predecessors: Ben Bernanke and Janet Yellen.
The next two-day FOMC meeting will be held on June 14 and 15.
Emel Akan contributed to this report.