Daily Management Review

US Fed Increases Rates, Allowing For A Break In The Tightening Cycle


US Fed Increases Rates, Allowing For A Break In The Tightening Cycle
The US Federal Reserve entered a new chapter in its management of the post-pandemic economic recovery by raising interest rates for the last time in history and paying closer attention to credit and other economic concerns.
As predicted by the financial markets, the U.S. central bank increased its benchmark overnight interest rate by a quarter of a percentage point to the 5.00%-5.25% range, but did so without using language in its policy statement that said it "anticipates" the need for additional rate hikes.
The adjustment does not preclude the central bank's policy-setting committee from raising rates once more when it meets in June, but Fed Chair Jerome Powell said it is now unclear whether additional increases will be necessary in an economy that is still experiencing high inflation, is beginning to show signs of slowing down, and faces the possibility of a stringent bank credit crackdown.
"We're closer, or maybe even there," Powell said of the end-point of rate increases that have boosted the Fed's policy rate by a full 5 percentage points in the 10 meetings since March 2022, a torrid pace for the central bank and one that may now warrant allowing some time for the impact to be felt in full.
The Fed stated that it would consider how the effects of monetary policy were building up in the economy "in determining the extent to which additional policy firming may be appropriate," using language similar to when it stopped its tightening cycle in 2006.
Inflation and the effects of credit tightening, which Fed officials believe are still developing in the aftermath of higher interest rates and a banking sector that has just been shaken by the failure of three U.S. banks, are front of mind.
Following the release of the statement, Powell held a press conference where he stated that inflation remains the main cause for concern and that it is therefore too early to declare the rate-hike cycle to be over.
"We are prepared to do more" he said, with policy decisions from June onward to be made on a "meeting-by-meeting" basis.
Additionally, he denied market speculation that the Federal Open Market Committee, which sets policy, would cut rates this year, stating that it was unlikely.
"We on the committee have a view that inflation is going to come down not so quickly, it will take some time," he told reporters, and "in that world, if that forecast is broadly right, it would not be appropriate to cut rates" this year.
Powell acknowledged that "policy is tight," but added that given the economy's growing strains, the possibility that banks' credit tightening may cause the economy to slow more than anticipated, and the Fed's continued optimism that a recession can be avoided, it's possible the central bank has raised rates enough.
The Federal Reserve's policy rate is currently at a level that most Fed members predicted in March would actually be "sufficiently restrictive" to bring inflation back to the institution's 2% target, which is about where it was on the verge of a destabilising financial catastrophe 16 years ago. Currently, inflation is still higher than the desired level.
The Fed stated in its statement that although economic growth is still modest, "recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation."
However, the Fed noted that job gains "have been robust," and Powell added that recent data on declining job openings and slower earnings growth, along with historically low unemployment, supported the notion that the economy could slow without a sharp increase in unemployment.
"The case of avoiding a recession is in my view more likely than that of having a recession," Powell said.
The dangers surrounding an impasse over the U.S. debt limit between Republicans in Congress and Democratic President Joe Biden have increased the sense of caution against attempts to further tighten monetary conditions.
U.S. interest rate futures, which generally indicated expectations for no hikes at either of the central bank's upcoming two policy meetings, reflected the Fed's change in strategy.
Following the release of the Fed statement, American stocks initially maintained their gains, but they later lost ground and closed lower. U.S. Treasury bond yields plunged, while the dollar fell against a basket of trading partners' currencies.
"For me the key was a change of a single word, saying that they believe that they will be determining whether future raises are necessary, whereas last time they said that they are anticipating that further rate hikes will be necessary," said Sam Stovall, chief investment strategist at CFRA Research. "With the word 'determining' in place of 'anticipating,' (it) is essentially telling the markets that the Fed is now on pause."