The Federal Reserve voted to raise the benchmark federal funds rate by 50 basis points, to a target range of 4.25–4.5 percent at the December policy-setting meeting of the Federal Open Market Committee (FOMC), the highest level since late 2007.
In total, the Federal Reserve has raised interest rates seven times since March, totaling 425 basis points.
The Fed thinks that inflation is still too high, and policymakers are monitoring the wide range of risks. In order to establish the pace of rate hikes, the central bank will look at cumulative tightening, economic and financial developments, and policy lags.
“Recent indicators point to modest growth in spending and production. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures,” the FOMC said in a statement.
“Russia’s war against Ukraine is causing tremendous human and economic hardship. The war and related events are contributing to upward pressure on inflation and are weighing on global economic activity. The committee is highly attentive to inflation risks.”
Each FOMC member voted for the December monetary policy action.
The FOMC also released the dot plot, a chart that records every Fed official’s projection for interest rates. The central bank expects interest rates will climb to 5.1 percent next year and then ease to 4.1 percent in 2024 and 3.1 percent in 2025. The fed funds rate will then slow to 2.5 percent.
According to the Fed’s Summary of Economic Projections (pdf), Board members forecast that the personal consumption expenditures (PCE) price index will reach the central bank’s 2 percent target by 2025.
The U.S. economy will expand just 0.5 percent in 2023, down from 1.2 percent in the September projection. The GDP will also advance by 1.6 percent in 2024 and 1.8 percent in 2025. The median unemployment rate is seen rising to 4.6 percent in 2023 and 2024 and dipping slightly to 4.5 percent in 2025.
The financial markets erased their gains following the announcement, with all three leading benchmark indexes in the red.
The slowing inflation rate and strong job growth are giving the Fed enough ammunition to continue to tightening without worrying about triggering a recession, says the Chair of the Department of Economics and Finance at Stephen F. Austin State University.
“On the one hand, this gives the Fed a green(er) light to continue to fight inflation without fearing an immediate onset of a recession; on the other hand, strong wage growth is part of the problem: the so-called inflationary spiral is the cycle of rising wages, increased spending, upward pressure on prices, the need to adjust wages, and so on,” he said in a report authored by personal finance outlet WalletHub.
At the same time, Ralph Axel, long-time interest-rate strategist at Bank of America, believes there will be multiple Fed pivots.
“We think markets have become too complacent about how simple the trajectory of the Fed, and therefore of markets, will be,” Axel said in a note. “The current market view is that it’s a single battle and once victory is declared, the game is over.”
Inflation or the Fed?
This decision comes after the Bureau of Labor Statistics (BLS) reported that the annual inflation rate eased to 7.1 percent in November, while the core inflation rate slowed to 6 percent. Looking ahead to the December Consumer Price Index (CPI), the Federal Reserve Bank of Cleveland’s inflation Nowcast model suggests a reading of 6.8 percent.
Despite investors initially celebrating the news on Tuesday, the stock market pared most of its gains. This has Ipek Ozkardeskaya, a senior analyst at Swissquote Bank, thinking that traders might care more about what the Fed says than what the data show.
“The S&P 500 futures gapped higher at the open, but gently softened to close the day with less than a 1 percent advance, without being able to clear the 4100 resistance and the y-ear-to-date bearish trend top,” she wrote in a note. “They know that the last thing the Fed wants is to reverse slowing inflation by triggering a bullish market euphoria.”
Meanwhile, the talk among many members of the rate-setting committee is that more work needs to be done to return to the central bank’s target rate of 2 percent. But when the Fed gets to that level is unclear at the moment.
Eric Peters, the CEO of One River Asset Management, does not believe the odds are in the Fed’s favor to bring the benchmark rate anywhere near close to 2 percent.
“We’re probably moving to an environment where inflation is between 3, 4, or 5 percent. Sometimes it goes a bit higher, sometimes it goes a little bit lower, but when you look at previous periods of higher inflation, they also have a lot of inflation volatility. So that’s what we need to live through right now,” Peters recently told Magnifi+, an AI-investing and trading platform.
There are many factors in place that will continue to send inflation higher and more volatile for longer, whether the institution pulls the trigger on a quarter- or half-point rate hike.
“We’re going to see in the early part of the year inflation heading in the direction of the consensus, and that’s going to make people feel pretty good about it. But we don’t think that it will sustain those levels. We think we’re going to end up with a materially higher inflation rate,” he added.
ING also believes long-term factors could push up inflation again, citing higher gasoline prices, deglobalization efforts, climate change policies, and extreme weather.
“Against this background of gradually declining but structurally higher inflation, the key question is what central banks will do if core inflation doesn’t return fully to target over the next 12 to 18 months,” the bank wrote in a recent note. “One option would be to keep policy rates high or higher for longer. The other option could be to become more flexible once inflation falls much lower. But it does suggest a return to consistently below-neutral interest rates is less likely in the medium-term.”
The next FOMC policy meeting will take place in February 2023, and most investors see a softer increase of 25 basis points, according to the CME FedWatch Tool.
From The Epoch Times