The Federal Reserve raised its benchmark lending rate by a quarter point on Wednesday, lifting interest rates to their highest level in 22 years. It’s the 11th rate increase since the Fed began its inflation fight in March 2022, and comes just one month after the central bank hit pause in order to assess the state of the economy after the failures of three regional banks since the spring.
Inflation remains elevated, Fed says
Inflation’s steady slowdown in recent months has been encouraging for American consumers and businesses, but officials reiterated in their post-meeting statement that “inflation remains elevated” and that the Fed “remains highly attentive to inflation risks,” suggesting that another rate hike remains on the table.
Fed officials are estimating one more rate hike this year, according to their latest set of projections. In a news conference following the decision, Fed Chair Jerome Powell underscored that another rate hike remains an option — if the economy were to pick up strength and keep upward pressure on prices.
“At the margins, stronger growth could lead over time to higher inflation and that would require an appropriate response for monetary policy,” Powell said. He also said that core inflation remains “pretty elevated”.
Bond market is pessimistic, stock market is not
The Fed’s tough talk has rattled the bond market, helping push up long-dated yields. The yield on the 10-year US Treasury note hit 4.3% on Thursday, its highest level in over a decade. Some investors are betting on rate cuts as soon as early next year, perhaps on expectations that the economy might soon deteriorate. If unemployment spikes because of higher interest rates, for example, the Fed would likely cut rates to stem job losses under its mandate of maximum employment.
However, the Fed hasn’t given any hint of rate cuts just yet. In fact, according to minutes from its last meeting in July, quite the opposite seems likely: more rate hikes this year.
“The expectations of the (bond) market versus the Fed’s guidance suggests that the bond market is pessimistic (about the economy) because it’s betting we have four rate cuts, while the stock market is not,” Mark Hackett, chief of investment research at Nationwide, told CNN.
Rate cuts would mean the Fed is looking to boost an economy that’s not doing well enough to promote full employment. In contrast, the Fed’s suggestion of rate hikes implies they see the US economy is still running too hot and might not be consistent with 2% inflation.
“You’re smart to pay attention to bond investors because historically, they’ve always been the adult in the room, but over the last 24 months or so, bond markets have been wildly pessimistic,” he said.
What’s next for the Fed?
The Fed’s next policy meeting is scheduled for September 19-20, when it will also update its economic projections and hold a press conference. Analysts expect that the Fed will announce its plans to start reducing its massive balance sheet of bonds and other assets that it accumulated during its stimulus programs after the financial crisis.
The balance sheet reduction is expected to have a gradual impact on long-term interest rates, as it will reduce the demand for bonds and put some upward pressure on yields. However, Powell has said that he expects the process to be “boring” and “run quietly in the background”.
The Fed’s main focus will remain on inflation and how it evolves in response to various factors, such as wage growth, energy prices, trade tensions and global developments. The Fed’s preferred measure of inflation, the core personal consumption expenditures (PCE) index, rose 3.5% in June from a year ago, well above the Fed’s 2% target.
Powell has said that he expects inflation to moderate as some of the transitory factors that boosted it fade away, such as supply chain disruptions and base effects from last year’s pandemic-induced slump. However, he has also acknowledged that there is uncertainty about how long and how much inflation will persist.
“We are navigating by the stars under cloudy skies,” Powell said of the Fed’s inflation fight during his Jackson Hole remarks earlier this month.
The Fed’s latest rate hike reflects its confidence in the strength of the US economy, despite some signs of slowing growth and rising risks from the Delta variant of the coronavirus. However, the central bank also faces a delicate balancing act between keeping inflation under control and supporting the recovery. The Fed has signaled that it is prepared to adjust its policy as needed, depending on how inflation evolves and how the economy responds to its actions. The Fed’s next move will depend on the data and the outlook, as well as on the progress of its balance sheet reduction plan.