Fed Hikes Rates by a Quarter Percentage Point Despite Recent Bank Failures

Andrew Moran
By Andrew Moran
March 22, 2023Business News

The Federal Reserve raised interest rates by 25 basis points, lifting the benchmark federal funds rate to a range of 4.75–5.0 percent, the highest since late 2007.

Fed officials say that the “banking system is “sound and resilient,” adding that the recent developments “are likely to result in tighter conditions for households and businesses,” which could weigh on economic activity, hiring, and inflation levels.

“The extent of these effects is uncertain. The committee remains highly attentive to inflation risks,” the Federal Open Market Committee (FOMC) said in a statement. The FOMC is the policy-making arm of the Fed.

Fed projections show that there will be one more quarter-point rate hike this year and cuts totaling 75 basis points in 2024.

Although the Fed’s balance sheet has experienced an expansion over the last week, the rate-setting FOMC confirmed that it will continue reducing its holdings of Treasurys, mortgage-backed securities, and agency debt.

According to the Survey of Economic Projections (SEP), the fed funds rate is expected to be 4.3 percent next year, up from the previous December estimate of 4.1 percent. Officials see the policy rate at 3.1 percent, unchanged from December. The longer-run rate also stayed the same at 2.5 percent.

“The committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time,” the committee added. “In determining the extent of future increases in the target range, 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.”

In addition, the Fed revised its GDP projections, lowering the growth rate from 0.5 percent to 0.4 percent this year. The Fed also adjusted its real GDP forecast for 2024, from 1.6 percent to 1.2 percent. The SEP also revised its 2025 GDP growth rate, from 1.8 percent to 1.9 percent.

The unemployment rate is seen rising to 4.6 percent by 2025, up from the December SEP of 4.5 percent.

On the inflation front, the Personal Consumption Expenditures (PCE) price index is predicted to slow, to 3.3 percent, in 2023, up from the December projection of 3.1 percent. PCE inflation is still expected to ease, to 2.5 percent in 2024 and 2.1 percent in 2025.

Core PCE inflation was revised slightly higher, to 3.6 percent this year and 2.6 percent in 2024. Core inflation is expected to slow, to 2.1 percent in 2025, unchanged from the December SEP.

U.S. financial markets were flat following the FOMC announcement.

The benchmark 10-year yield shed more than 6 basis points, to around 3.54 percent.

The U.S. Dollar Index (DXY), which gauges the greenback against a basket of currencies, tanked roughly 0.6 percent, to around 102.6.

Did the Fed Need to Cut Rates Instead?

Since the start of the banking crisis, only a small number of economists and prominent market personalities have suggested that the Fed needed to slash interest rates to support the financial system.

In response to a tweet by hedge fund manager Bill Ackman, who said the central bank needed to pause, Tesla Motors and Twitter CEO Elon Musk advocated for a cut.

“Fed needs to drop the rate by at least 50 bps on Wednesday,” Musk said on Monday.

Only one bank, Nomura Securities, supported Musk’s recommendation.

Nomura economists had anticipated that the Fed would cut its benchmark interest rate by a quarter-point and suspend the reduction in the size of its $8.6 trillion balance sheet.

The Fed should begin cutting interest rates immediately, says Bryce Doty, the senior vice president and senior portfolio manager at Sit Investment Associates.

“The Fed can cut rates and immediately reverse some of the damage,” Doty wrote in a note on Monday, adding that many of today’s challenges could have been avoided if the Fed recognized inflation earlier.

“Instead of raising rates slowly and cease printing trillions of dollars when the economy first reopened, the Fed didn’t begin raising rates until a year ago after year-over-year inflation had surpassed 7 percent,” he said.

Some experts have argued that the Fed no longer needs to be aggressive in the current hiking cycle, alluding to slowing inflation.

In February, the Consumer Price Index (CPI) eased to 6.0 percent, and the core CPI slowed to 5.5 percent.

Despite widespread liquidity fears that could threaten the banking system, the futures market sees the central bank letting up on its quantitative tightening campaign in December, according to the CME FedWatch Tool.

However, some economists present the case that the Fed has potentially started slowing down its tightening, citing the dramatic increase in the balance sheet. The Fed’s balance sheet for the week ended March 16 increased nearly $300 billion, to just under $8.64 trillion.

From The Epoch Times

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