The Federal Reserve on Wednesday raised benchmark interest rates by another three-quarters of a percentage point and indicated that it would continue to rise above the current level.
In its quest to bring down inflation near its highest levels since the early 1980s, the central bank raised the federal funds rate to the 3%-3.25% range, its highest level since early 2008, after its third consecutive 0.75 percentage point move.
Stocks swayed after the announcement, with the Dow Jones Industrial Average recently down slightly. The market swung as Federal Reserve Chairman Jerome Powell discussed the outlook for interest rates and the economy.
Traders were concerned that the Fed was still more hawkish for longer than some had anticipated. Expectations from the meeting indicated that the Fed expects to raise interest rates by at least 1.25 percentage points at its two remaining meetings this year.
The main message has not changed.
“My main message has not changed since Jackson Hole,” Powell said in his post-meeting press conference, referring to his policy speech at the Federal Reserve’s annual symposium in August in Wyoming. “The FOMC is very intent on bringing inflation down to 2%, and we will continue to do so until the job is done.”
The March increases – and from a point close to zero – represent the most tightening by the Fed since it began using the overnight money rate as a major policy tool in 1990. The only comparison was in 1994, when the Fed raised the total 2.25 percentage points; The interest rate cut will start by July of the following year.
Combined with the massive interest rate increases, Fed officials have indicated an intention to keep rising until the money level reaches a “final rate,” or end point, of 4.6% in 2023. That means a quarter point rate hike next year but without lowering.
The “dot plot” of individual member expectations does not refer to rate cuts until 2024. Powell and colleagues have emphasized in recent weeks that rate cuts are unlikely next year, as the market has been pricing.
FOMC members indicate that they expect higher interest rates to have consequences. The rate of money ostensibly addresses the rates banks charge each other for overnight lending, but it flows through many consumer adjustable debt instruments, such as home loans, credit cards and auto financing.
In their quarterly updates of rate estimates and economic data, officials gathered around expectations for the unemployment rate to rise to 4.4% by next year from the current 3.7%. Increases in this magnitude are often accompanied by a stagnation period.
Besides, they see GDP growth slowing to 0.2% for 2022, then picking up slightly in the following years to a longer-term rate of just 1.8%. The revised forecast is a sharp drop from the 1.7% estimate in June and comes after two consecutive quarters of negative growth, a generally accepted definition of a recession.
Powell acknowledged that a recession is a possibility, especially if the Federal Reserve is to continue tightening aggressively.
“No one knows if this process will lead to a recession or, if so, how significant that recession will be,” he said.
The increases also come with hopes that overall inflation will fall to 5.4% this year, according to the Fed’s preferred PCE price index, which showed inflation at 6.3% in July. The Economic Outlook summary then sees inflation fall back to the Fed’s 2% target by 2025.
Core inflation excluding food and energy is expected to fall to 4.5% this year, little changed from the current 4.6%, before eventually declining to 2.1% by 2025. (The PCE reading was well below consumer price index).
The decline in economic growth came despite the FOMC statement spreading language that in July described spending and production as “weak”. The statement of this meeting indicated that “recent indicators point to modest growth in spending and production.” Those were the only changes to a statement that won unanimous approval.
Otherwise, the statement continued to describe job gains as “strong” and noted that “inflation remains elevated.” She also reiterated that “continued increases in the target rate would be appropriate”.
“75 is the new 25”
The bullet plot showed nearly all members on board with higher rates in the near term, although there were some differences in later years. Six of the 19 “points” were in favor of taking rates into the 4.75%-5% range next year, but the central trend was to 4.6%, which would put rates in the 4.5%-4.75% region. The Fed targets its funding rate in quarter point ranges.
The chart indicated as many as three interest rate cuts in 2024 and four more in 2025, lowering the long-term funds rate to a median forecast of 2.9%.
Markets were preparing for more Fed.
“I think 75 is the new number 25 until something breaks, and nothing breaks yet,” said Bill Zox, portfolio manager at Brandywine Global, referring to the scale of the price hike. “The Fed is not close to any pause or fulcrum. They are laser-focused on breaking inflation. The key question is what else they can break.”
Traders priced the move a full 0.75 percentage point, and even gave an 18% chance of raising a full percentage point, according to data from CME Group. Futures contracts just before Wednesday’s meeting are pointing to an interest rate of 4.545% by April 2023.
The moves come amid stubborn high inflation that Powell and his colleagues have spent most of the past year calling “temporary.” Officials fell back in March of this year, with a quarter-point increase that was the first increase since rates were raised to zero in the early days of the Covid pandemic.
Along with increasing the interest rate, the Fed is working to reduce the amount of bond holdings it has accumulated over the years. September saw the start of high-speed “quantitative tightening”, as the markets are known, with up to $95 billion per month in maturing bond yields allowed to be pushed out of the Federal Reserve’s $8.9 trillion balance sheet.