Fighting the Inflation Fire
The Federal Reserve raised rates by the greatest amount in 28 years, in an effort to aggressively fight the flames of inflation, and expects the target fed funds rate to finish the year at 3.4%.Download PDF
- As expected, the Federal Open Market Committee (FOMC) increased the federal funds target rate range to 1.50% to 1.75%, a 0.75% increase.
- Median projections from the committee members showed three potential 50 basis point hikes in the fed funds rate in 2022, or two more 75 bps hikes for the year, with one potential 25 bps hike in 2023 and a rate cut in 2024.
- The Fed’s second economic outlook for 2022 showed a material change in GDP and inflation, as GDP estimates moved lower from 2.8% to 1.7% while the core PCE price index was increased from 4.1% to 4.3%.
- The committee also included strong language in its statement that clearly reaffirmed the FOMC’s commitment to return inflation back to its 2% objective.
At their June meeting, Federal Open Market Committee (FOMC) members agreed to hike the fed funds rate by 0.75%, raising it to the 1.50% - 1.75% range. It was the first 75 basis point (bps) hike in 28 years. Fed fund futures started the week with a 100% probability of a third hike and were little changed. Market expectations changed from last week, demonstrating that investors believed a 75 bps hike was warranted versus prior expectations for a 50 bps hike to slow inflationary pressures.
With US inflation hitting a 40-year high of 8.6% in May, a 1% increase from April, the Fed needed to respond with greater force as price pressures have become entrenched in the US economy. The Fed has indicated that its primary tool to combat inflation will remain rate hikes, although a large balance sheet remains that the Fed voted to reduce through the reinvestment caps of the System Open Market Account (SOMA). As of June 1, principal payments from securities held in the SOMA will be reinvested to the extent that they exceed the monthly caps of $30 billion for Treasury securities and $17.5 billion for agency debt and agency mortgage-backed securities. After three months, those caps will increase to $60 billion per month for treasuries and $35 billion per month for agency debt and agency mortgage-backed securities.
As for the economy, the Fed lowered estimates for GDP growth in 2022 from 2.8% to 1.7%, which now sit below the committee’s long-term estimates. The Fed raised inflation estimates from 4.1% to 4.3% as the current actions taken by the committee have yet to calm inflationary pressures. Unemployment projections increased from 3.5% to 3.7%, with projections for unemployment crossing 4% in 2024, as record high inflation and slower economic growth are expected to weigh on labor market conditions over the next few years.
Below are the language changes made in the Fed’s statement from May:
Here are the committee’s June projections for GDP, unemployment, inflation, and the federal funds rate for 2022 through 2024:
The committee’s “Dot Plot” showed noticeable increases in the projections for the fed funds rate in 2022, 2023, and 2024. The chart showed 13 of 18 committee members expecting at least 3 more 50 bps rate hikes in 2022, and the majority of committee members expect the benchmark rate to be above 3.5% by 2023. The median committee member saw only one rate hike by 2023 and a potential 25 bps decrease in 2024. Five officials projected a fed funds rate above 4% in 2023.
After the Fed announcement, the 10-year Treasury ended the day lower by 16 basis points to 3.33%; short and long rates also finished the day lower.
10 Year Treasury Yield Over the last 12-months
Markets closed in positive territory on the final day of the FOMC meeting, as both the Dow Jones Industrial Average and S&P 500 Index moved higher during Chairman Powell’s press conference. The Dow and S&P 500 finished the day up 1.00% and 1.46%, respectively. As the committee dialed in on reigning in inflation more aggressively than in past meetings, Treasury yields across the curve decreased following the release of the Fed’s statement.
Investors were prepared for the Fed to take a hawkish turn, and the committee delivered on expectations with a 75 bps hike in the benchmark rate. Fed Chair Jerome Powell said the impact of current rate hikes have done little to slow inflation, and that waiting another six weeks to hike rates by a greater amount than initially expected was not the correct decision in light of current data. Chair Powell also left open that markets could see a similar move in July by the committee, as Powell mentioned that there would likely be a debate between a 50 bps and 70 bps hike at the next meeting. While this move may likely take time to impact markets and prices, the Fed expects higher borrowing costs to dampen demand and inflation. This meeting also demonstrated that committee members see the economy slowing significantly as a result of rate hikes and unemployment may likely head higher over the next few years. For now, the move today appeared to soothe investor concerns. We will have to wait and see whether the more hawkish path of the Fed will quell the flames of inflation.
One basis point is equal to 0.01%.
The Dow Jones Industrial Average index (DJIA) tracks the share price of the top 30 large, publicly-owned U.S. companies which is often used as an indicator of the overall condition of the U.S. stock market.
Gross Domestic Product (GDP) is the total monetary or market value of all the finished goods and services produced within a country's borders in a specific time period.
Personal Consumption Expenditures (PCE) refers to a measure imputed household expenditures defined for a period of time.
The S&P 500 index is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the U.S. stock market.
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