The Federal Reserve has been aggressively raising interest rates to combat inflation that has been triggered by the pandemic and the war in Ukraine. Although recent inflation data is promising, the path ahead is not clear.
Inflation has dropped to 6.5% in the U.S. but despite signs of slowing over the past six months, it remains elevated and near its highest level since the early 1980s. On the other hand, core inflation, which excludes food and energy prices, has not peaked yet. Therefore, for the Fed it’s a difficult balance between avoiding a painful recession and preventing high inflation from returning.
Overall, investors expect rates to peak this spring, but the full impact won’t be clear until next year. The Fed wants to cool hiring and wage increases, which drive up inflation, but this will result in some pain and higher unemployment.
On Wednesday, the Federal Reserve increased interest rates by 25 basis point and indicated a need to tighten monetary policy further in its effort to combat inflation. The Federal Open Market Committee raised its benchmark rate to a range of 4.5% to 4.75%, the highest level since October 2007, in line with market expectations.
The February hike marks the second decrease in interest rates increases by the Federal Reserve after a slowdown to 50 basis point at the December meeting, following four consecutive 75 basis point increases in 2022.
The markets were hoping for signals that the Fed would end its rate hikes, but no such signals were provided. At the December meeting, the Fed raised its benchmark rate to a median rate of 5.1% in 2023, with a range of 5.00% to 5.25%, indicating that three more 25 basis point hikes could be expected in 2023. The first-rate hike of 2023 has not changed the Fed’s stance to continue moving toward its target range.
Fed Chair Jerome Powell acknowledged at the press conference that followed the monetary policy statement, that disinflation has started in the goods sector, driven by easing in supply chain shortages, but cautioned against declaring victory too early.
He also stated that the current monetary policy stance is not yet restrictive enough, which is why the Fed expects ongoing hikes to be necessary. However, markets rebounded during Powell’s press conference with the NASDAQ 100 index closing sharply higher – gaining 2% for the day.
