The Federal Reserve raised the federal funds rate by 50 basis points on Wednesday, a reprieve from several other higher rate hikes in 2022. The Fed’s interest rate hike in one year will hit the country.
In its quest to curb inflation, the Federal Reserve has previously raised the federal funds rate by 75 basis points four times in 2022, after two small hikes. The Fed’s rate hike ends up making credit more expensive for consumers and businesses, and it’s one of the Fed’s few tools to fight inflation.
The final increase for the year occurred on Wednesday and reflects the increase in May. The current Fed rate is now in the range of 4.25%-4.50%.
“Our focus is not on short-term moves, but on permanent moves,” Federal Reserve Chairman Jerome Powell said at a press conference following the rate hike. “We are not yet on a sufficiently restrictive policy, so we say we expect the current increases to be appropriate.”
All markets fell sharply after the Fed’s announcement.
Until 2022, there hasn’t been a single 75 basis point increase since 1994, let alone three in one year. But the stakes have been this high and even higher many times before, most recently from 2005 to 2007. Indeed, rates were 4% or higher for much of the 1990s through 2001, and around 20% in the early 1980s.
Does raising rates work?
The Fed is using rate hikes to slow economic growth, making it more expensive for consumers and businesses to get credit. This keeps consumers and businesses from spending, reducing the demand for goods and services and hence prices.
It is not yet clear whether the Fed’s interest rate leverage is succeeding in keeping inflation in check. But there are signs that in some areas, though not all, things are moving in the direction the Fed wants.
The rate of inflation has slowed down. The latest CPI report, released on Tuesday by the Bureau of Labor Statistics, shows a lower-than-expected inflation rate of 7.1%. This is below a peak of 9.1% in June. The core consumer price index, which excludes food and energy price volatility, also came in below expectations. While inflation appears to be slowing down, it is still well above the Fed’s 2% target.
The housing market has fallen. The buying boom in the early years of the pandemic, when mortgage rates were at record lows, ended and borrowing costs hit a 20-year high in November, data from Freddie Mac shows. Existing home sales fell for the ninth straight month in October, according to the National Association of Realtors. But it’s also possible that mortgage rates have peaked.
Consumers will pay more to pay off debt. Higher interest rates mean that any debt you take on now and in the new year will be more expensive than it was a year ago. This includes new loans and floating rate loans such as mortgages, auto loans, personal loans, and credit card debt. Having more expensive existing debt is likely to lead to excess savings by consumers and may deter them from spending.
Consumer spending has fallen, but not enough. According to the US Bureau of Economic Analysis, despite higher prices for goods and services, consumers have not significantly reduced their spending, mainly due to higher wages.
“Everyone is very pessimistic about the economy, except when they are in the box office,” says Mike Konchal, director of macroeconomic analysis at the Roosevelt Institute. “They are still buying a lot and it looks like we still have some pretty solid growth even as we see inflation starting to slow down.”
But high costs aren’t the only factor that comes into play. Konchal says supply issues are also overlooked by many.
The force of employment is maintained. When you slow demand, it also often means people lose their jobs and wage growth slows, but neither has happened yet. In fact, the U.S. labor market is doing phenomenally, with more jobs than expected in the economy in November, and key indicators — labor force participation, layoffs, and job openings — holding steady. Layoffs have already affected certain sectors of employment, including technology and the media, but they have not yet become widespread. The Fed would prefer unemployment to be above its current level of 3.7% and forecast unemployment to hit 4.4% in 2023.
“The main thing that characterizes the economy this year is a very strong labor market with very high growth in nominal wages, very high labor market growth and very high number of job transitions,” says Konchal.
Will the Fed keep raising rates in 2023?
On Wednesday, the Fed signaled it would continue raising the federal funds rate in 2023 and reaffirmed its commitment to its 2% inflation target.
“We have done a lot of work and the full impact of our rapid tightening is yet to be felt. However, we still have a lot of work to do,” Powell, the chairman of the Fed, said at a press conference on Wednesday.
The Fed’s target rate forecast for 2023 is now 5.1%. It’s unclear how quickly the Fed will raise rates to that level, but Powell said at a press conference that speed is no longer a priority.
How high future interest rate hikes are will depend on overall financial conditions and how quickly inflation falls. There are still global inflationary factors that the Fed has no control over, including supply chain bottlenecks and geopolitical instability. And at home, high wages and low unemployment appear to be challenging the Fed’s efforts.
“I think inflation can come down without a significant increase in unemployment, or without a significant increase at all,” says Konchal. “Whether it drops enough to make the Fed happy is a big open question, and how much patience it will take [the Fed] is there if it will come off, but not completely?
Economists do not understand what exactly awaits the US economy in 2023. But if the forecasts for 2021 relative to 2022 have shown us anything, it’s that the economic forecasts are wrong.
“Wall Street, the banks, the professional forecasters all sort of missed high inflation and I think this year people were expecting it to be narrow in terms of what it hit and come back a little faster,” he says. Finished.
At this point, one can only wonder if we will make a soft landing, enter a mild short-term recession, or fall into a full-blown global recession, as investment management firm BlackRock recently predicted. .