Fed hikes rates by 75 basis points; hits two milestones ahead of GDP data – Invezz | Gmx Pharm

In line with market expectations, Chairman Powell and FOMC members raised the federal funds rate by 0.75% for the second consecutive day.

In a unanimous vote, the policy corridor was raised to 2.25%-2.50%, marking the fastest pace of tightening since 1981 in response to June’s rise in retail inflation to 9.1%.

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The Fed has reiterated that in line with its June roundup of economic forecasts, interest rates are expected to be raised to 3.25-3.5%, suggesting that the institution could hike another 100 basis points by year-end despite the pace want is not clear yet.

Crucially, the Fed has achieved two important milestones:

  • Alignment of the policy rate with the neutral rate, a theoretical point at which economists expect interest rates not to be too low to stimulate economic activity or too high to constrain economic activity. For the United States, this is often assumed to be around 2.4%.
  • Reaching the peak of the previous growth cycle, ie 2.5% in 2019, before reversing.

Aside from rate hikes, the Fed will also continue quantitative tightening at a rate of $47.5 billion per month, which includes both government bonds and mortgage-backed securities. This quantity is to be doubled in September.

The Immediate Impact

With higher interest rates, corporate and household debt becomes more expensive, especially for holders of adjustable-rate loans.

When the Fed’s interest rate rises, debt becomes more expensive across the board, and because the US is largely a debt-driven society, the cost of borrowing for personal, consumer, and corporate spending rises. With local banks in the US bearing much of the burden, local, state and national banks are likely to tighten lending practices, particularly for small businesses.

With tighter bank measures not only on interest rates but also with the introduction of stricter risk management measures and capital requirements, small businesses could find their access to finance dried up.

Households would face similar challenges as the cost of 0% debt relief soared earlier this year and pandemic relief has largely been exhausted.

Fears of inflation giving way to fears of recession?

The political narrative has started to shift and markets are increasingly concerned about a recessionary versus inflationary future.

For example, a recent poll found that 63% of respondents expected the Fed’s 2% policy would result in a recession, while 22% believed not. In addition, 55% of the financial market participants surveyed, including fund managers and financial analysts, assume that the USA will be in a recession in the next 12 months.

One of the key elements contributing to recessionary sentiment is the ongoing decline in commodity prices.

Source: MarketWatch

To curb inflation, which is still heating up in the United States, Powell stated, “We think a slowdown in growth is necessary…we need a period of below-potential growth to create some slack to allow the supply side to catch up.” As a result, he believes another “unusually large” rate hike could be on the cards at the September meeting to dampen consumer demand if “inflation continues to disappoint”.

However, he added that “additional tightening is likely in the pipeline” due to the delayed economic response to monetary policy decisions. Simply put, money transmission is not an instant process and would require oversight by the Fed to prevent a slide into recession

Transmission is the mechanism by which changes in Fed interest rates reverberate throughout the economy until they achieve intended policy goals for growth and inflation.

According to the San Francisco Fed, “…the biggest impacts on production can last anywhere from three months to two years. And the impact on inflation tends to have even longer lags, maybe a year to three years or more.”

The FOMC’s press release said in the opening sentence that “recent spending and manufacturing indicators have eased,” suggesting that Chairman Powell believes the committee also needs to actively monitor recessionary risks.

Greg McBride, chief financial analyst at Bankrate, believes it’s too early for the Fed to water down its rate hikes as the CPI is still at a four-decade high and the PPI, a leading indicator of the CPI, is at 11 .3% was recorded. on an annual basis. However, he expects the pace of rate hikes to slow as inflation eases.

Chris Hurn of Fountainhead, a small business lender, supported the view that rate hikes must continue for the foreseeable future, stating: “A few hundred basis points people can take.”

Way forward and forward guidance

Interestingly, Jerome Powell has shifted his stance from a cautious and intentional forward bias, stating that the FOMC will not provide “clear guidance on how to move towards neutrality” while continuing to rise to moderate levels.

He reiterated during the question-and-answer session that policy decisions would be made on a “meeting-to-meeting” basis and adjustments to the intended path would depend on incoming data.

This is partly because markets are significantly more uncertain amid global geopolitical infighting, the spread of Covid and other potential supply shocks.

The next Fed meeting is scheduled for September after an 8-week pause before the FOMC will benefit from a slew of fresh economic data including Q2 GDP data, two CPI data, two jobs updates and a longer time series of commodity prices.

Although another rate hike is expected in September, it will be interesting to see if the Fed can hike rates on the basis of its broad plans given the pandemic-related fiscal stimulus and debt levels, as well as retail inflation, are much higher than for the year 2018, or whether it will be forced into a 2019-style reversal by recession concerns.

Economists at Bank of America Securities have already lowered their Fed rate expectations and expect the Fed to reverse course in early 2023.

upcoming dates

US GDP data will be released tomorrow and will set the crucial direction for the upsides to follow.

In the first quarter, US GDP was -1.6%. Market observers will be curious to see whether there will also be a contraction in the second quarter of the year.

Two straight quarters of contraction are often taken as a sign that the economy is in recession. Strictly speaking, that’s not true. US recessions are identified by the National Bureau of Economic Research (NBER).

NBER explains: “The determination of the high and low months is based on a series of monthly measurements of aggregate real economic activity released by the federal statistical offices. This includes real personal income net of transfers, non-farm payrolls employment, household survey employment, real personal consumption expenditure, price-adjusted wholesale and retail sales, and industrial production. There is no hard and fast rule as to what actions bring information into the process or how they are weighted in our decisions.”

Thus, US definitions of a recession are actually subject to the judgment of the experts responsible for dating business cycles.

Earnings data released later this week will also provide a preliminary indication of where consumer spending is heading and what scope there might be for corporate reinvestment.

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