The US Federal Reserve raised its benchmark interest rate by a quarter of a percentage point on Wednesday but warned that “ongoing increases” are needed to bring inflation under control.
The downgrade to a quarter-point rise marked a return to a slower, more orthodox pace of rate hikes after the Fed’s rapid increase in borrowing costs over the past year, and reflected the fact that inflation appears to have peaked during the year the economy begins to weaken.
However, in a statement, the Fed claimed that “ongoing increases in the target range will be appropriate” to ensure it limits activity enough to bring price pressures under control. This indicated that the central bank is inclined to raise borrowing costs further at its next meeting.
The Federal Open Market Committee’s latest hike takes the federal funds rate to 4.5 percent to 4.75 percent, the highest since September 2007. The Fed added that while inflation “has eased somewhat,” it is still ” increased”.
In a press briefing, Fed Chair Jay Powell said that while there had been some “encouraging” signs that inflationary pressures were easing, policymakers “needed a lot more evidence to be confident that inflation was on a sustained downward path.” located”.
Powell signaled that Fed officials remain primarily concerned with the risks of doing too little to tame inflation rather than over-squeezing the economy.
“It’s very difficult to take the risk of doing too little and finding out in six months or 12 months that we were close but didn’t get the job done,” he said. “When we feel we’ve gone too far . . . Inflation is falling faster than we expect, then we have tools that would work on that.”
He added: “You know, the job isn’t fully done yet. . . so I think it’s premature. . . very premature to announce victory.” He also appeared to rule out pausing rate hikes and resuming them at a later date, suggesting that the central bank would prefer to do all tightening in one cycle.
Despite Powell’s comments, markets rallied strongly during and after the press conference as traders focused on a few dovish comments from the Fed Chair, including the fact that he was able to say that “for the first time the disinflationary process has begun”.
Some investors were heartened by Powell’s more relaxed response to the recent easing in financial conditions, saying the Fed’s focus is “not on short-term moves.”
The benchmark S&P 500 and the tech-heavy Nasdaq rose to their highest levels since August and September 2022, respectively. Investors bought government bonds, with the two-year government bond yield, which moves with interest rate expectations, falling to a two-week low.
The dollar index, which measures the greenback against a basket of six currencies, fell to its lowest level since April 2022.
The quarter-point rise marked a break from the unusually large half-point and three-quarter-point rate hikes the Fed had relied on in 2022 as it struggled with rising inflation. In contrast, the European Central Bank and the Bank of England are expected to raise interest rates by 0.5 points on Thursday.
Bob Michele, chief investment officer at JPMorgan Asset Management, said the statement was “very hawkish,” but said the news conference was more dovish because Powell acknowledged it would take time for the full impact of recent rate hikes on the economy to seep through.
“You’re nearing the end of the migration cycle,” Michele said. “We think they will make a 0.25 percentage point hike in March, which will be the last hike. [Powell] reversed everything in the press conference, which is why you got the reaction in the markets.”
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In December, most officials were forecasting that the fed funds rate would reach between 5 and 5.25 percent this year and stay at that level through 2023.
Fed officials have held onto this line of thinking for the past few weeks. If December’s trajectory still holds, it suggests the central bank will make two more quarter-point rate hikes beyond Wednesday’s hike.
But policymakers have been unable to convince money managers and traders in the Fed fund futures markets. The market is pricing in a top rate of just under 5 percent in the second quarter and a 0.5 percentage point cut by the end of the year.
That set the stage for what Tobias Adrian, the IMF’s head of money and capital markets, warned could come as a shock if future inflation data disappoints and the Fed tightens further as a result.
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