By Andrew Moran
The Federal Reserve raised interest rates by 25 basis points, lifting the benchmark federal funds rate to a range of 5.00 and 5.25 percent, the highest level since September 2007.
The vote to raise rates by a quarter point was unanimous, according to a statement from the Federal Open Market Committee (FOMC).
Markets had mostly priced in a rate hike, so investors were more focused on forward guidance than the May policy decision.
The post-meeting statement opened the door to a rate pause after it removed “the Committee anticipates that some additional policy firming may be appropriate” sentence.
“In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments,” the Fed said in a statement.
Futures markets are now showing that traders are pricing in a pause at the June FOMC meeting and then a cut in September.
On the banking front, the Fed reiterated that the “banking system is sound and resilient,” adding that tighter credit conditions will likely “weigh on economic activity, hiring, and inflation.”
“The extent of these effects remains uncertain,” the post-FOMC meeting statement said.
“Economic activity expanded at a modest pace in the first quarter,” the FOMC stated. “Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated.”
Stocks were slightly higher following the Fed announcement, with the leading benchmark indexes rising about 0.2 percent.
Peter Schiff, the chief economist and global strategist at Euro Pacific Capital, does not think the quarter-point rate hike will achieve much in the Fed’s broader inflation fight.
“Consumer prices still have a long way to rise due to past QE and will rise even further as a result of future QE as the Fed soon responds to a worsening financial crisis,” he tweeted.
A Call to Pause
With First Republic Bank failing—the third such failure since March—a chorus of experts had urged the Fed to hit the pause button on its tightening cycle heading into the much-anticipated meeting.
Paul Donovan, the UBS Global Chief Economist, told Bloomberg on May 3 that he “wouldn’t be hiking” if he were running the Federal Reserve.
Former Dallas Fed Bank President Robert Kaplan also told the business news network that the central bank should do “a hawkish pause,” citing the banking turmoil that he believes is in the early stages. This policy maneuver would leave interest rates unchanged but also “signal that we’re in a tightening stance.”
U.S. lawmakers had also recommended that the Fed refrain from pulling the trigger on rate hikes.
Ten senators and representatives, led by Sen. Elizabeth Warren (D-Mass.) and Sen. Bernie Sanders (I-Vt.), penned a letter to Chair Powell warning that an “overreaction” would leave the economy “vulnerable” to a recession “that destroys jobs and crushes small businesses.”
The public wanted the Fed to stop raising rates, too.
A recent Lake Research Partners poll found that 56 percent of U.S. voters thought the central bank needs to stop with the rate hikes.
“Our new poll makes it clear that people across the country want the Federal Reserve to stop raising interest rates before it pushes us toward a devastating and completely avoidable recession,” said Rakeen Mabud, chief economist at the Groundwork Collaborative.
The Fed’s tightening campaign has impacted consumers’ wallets, new research from WalletHub found.
The personal finance website’s recent Fed Rate Hike Survey found that nearly 70 percent of Americans reported their finances taking a hit because of higher interest rates, and 46 percent say the Fed’s rate hikes will impact their summer plans.
Economists projected that the Fed’s quarter-point increase would cost credit card users an additional $1.7 billion in the next 12 months. Overall, the 500-basis-point spike in the FFR since March 2022 is expected to cost consumers with credit card debt about $33.4 billion over the next 12 months.
“In fact, the 25-basis-point rate hike expected on May 3 has already increased the cost of the average 30-year mortgage by roughly $11,600, given that rate hikes are usually priced into mortgage rates in advance,” added Jill Gonzalez, a WalletHub analyst.
Recession, Inflation, or Banking Crisis
In recent months, economists have asserted that the Fed is stuck between a rock and a hard place on interest rates. If Powell keeps raising interest rates, he might exacerbate the banking turmoil and trigger a recession. On the other hand, if he hits the pause button, he could enable the reacceleration or stickiness of inflation.
But critics will purport that all three events are happening anyway.
Since March, there have been three bank failures. Moreover, there are fears that there could be more small- and mid-size collapses in the coming months, contributing to the sharp selloff in regional bank stocks. PacWest Bancorp, for example, has cratered about 43 percent in the past week on deposit flight concerns.
In the first quarter, personal consumption expenditure (PCE) prices climbed to 4.2 percent, and core PCE, which strips the volatile food and energy sectors, advanced to 4.9 percent. The annual PCE price index eased to 4.2 percent in March, but the core PCE slowed to a higher-than-expected 4.6 percent.
In addition, the employment cost index rose 1.2 percent in the first three months of 2023, up from 1.1 percent in the fourth quarter and higher than the market estimate of 1.1 percent.
When it comes to a recession, this has become the consensus for many economists, policymakers, and market analysts.
“Versus the market, we are less sanguine that inflation is going to come down, and more certain that we are entering a recession and risk assets are priced too richly for that outcome,” wrote Mimi Duff, the managing director at investment management firm GenTrust, in a research note, adding that there is no expectation for the Fed to employ rate cuts this year.
Fed economists anticipate a recession later this year, according to minutes released from the March FOMC meeting.