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The Federal Reserve is most likely done raising interest rates this cycle. It just wants everyone to believe something else. That came from the statement released by the central bank on Wednesday to explain its decision to raise its key interest rate by a quarter of a point as expected, down from December’s half a point hike. Here is their key part:
The Committee believes that further increases in the target range will be appropriate to achieve monetary policy sufficiently restrictive to return inflation to 2% over time.
Two things stand out. The first is that it merely repeats the language policymakers used in previous statements when raising interest rates by larger amounts to combat raging inflation. Some market participants had expected the Fed to replace “ongoing hikes” with softer words like “some hikes”.
The reason a change was expected is because inflation is slowing and manufacturing is in recession. The Institute for Supply Management said on Wednesday that its gauge of factory activity signals production is the weakest since 2009 (excluding the early days of the pandemic) and that 15 out of 18 industries saw business fall.
Second, interest rates are finally at levels that can be viewed as restrictive or as dragging rather than stimulating economic activity. At 4.75%, the upper end of the central bank’s target for the federal funds rate exceeds the Fed’s preferred measure of inflation, which is the central price index for private consumption. That figure came in at an annualized 3.9% in the fourth quarter last week, according to the Department of Commerce. Aside from the early days of the pandemic, it’s the first time since 2019 that interest rates can be considered hawkish, when everyone was anticipating an imminent recession.
For this reason, the swap market is pricing in a 5% prime interest rate, rather than the 5.25% or higher signaled by the Fed. The market believes interest rates are essentially where they need to be to meet the Fed’s main goal of bringing inflation down to around 2% levels. In fact, the derivatives markets are pricing in an inflation rate of around 2.25% for each of the next two years.
Politicians may think so too, but they have a different agenda. They will continue to send an aggressive message to keep markets in doubt. Finally, an unpredictable Fed will keep markets on the defensive, which is attractive to the central bank as it seeks to prevent financial conditions from becoming too loose and putting upward pressure on inflation. Here is Fed Chair Jerome Powell in his post-rate hike press conference:
“It is important that overall financial conditions reflect the actions of the Fed.” “Our focus is not on short-term moves but on sustained changes” in financial conditions, adding that “a few” more rate hikes may be needed.
Still, the market cheered as the S&P 500 index fell from as low as 0.97% to as high as 1.77% and bonds rallied. Markets know the Fed is probably just making the moves now, saying its job is far from done. This may not be the turning point investors have been waiting for, but it is certainly a pirouette. More from the Bloomberg Opinion:
• Is the US economy at risk of rewarming?: Tyler Cowen
• The Fed may need a new excuse to stay Hawkish: Jonathan Levin
• Which recession? Makers Plan Editions: Brooke Sutherland
This column does not necessarily represent the opinion of the editors or of Bloomberg LP and its owners.
Robert Burgess is Editor-in-Chief of Bloomberg Opinion. Previously, he was Global Editor-in-Chief for Financial Markets at Bloomberg News.
For more stories like this, visit bloomberg.com/opinion
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