The Federal Reserve raised interest rates by 25 basis points, meeting market expectations and bringing the key federal funds rate to a target range of between 4.50 and 4.75%.
This was the smallest rate hike since the current round of quantitative tightening began in March 2022.
Central bank officials believe further hikes will be needed to get “a tight enough monetary policy stance,” according to a Federal Open Market Committee (FOMC) statement. While inflation has slowed, it remains too high for the US economy.
“Recent indicators point to modest growth in spending and output. Job gains have been robust in recent months and the unemployment rate has remained low. Inflation has eased slightly, but remains high,” the FOMC said.
“Russia’s war against Ukraine is causing enormous human and economic hardship and contributing to high global uncertainty. The Committee is very attentive to the risks of inflation”.
However, when determining the size and pace of future rate hikes, policymakers will consider policy lags, economic and financial developments, and cumulative tightening in their decision-making.
The rate-setting committee will continue to reduce its holdings of Treasuries, agency debt and agency mortgage-backed securities.
“The Committee is strongly committed to returning inflation to its 2% target,” the statement read.
The market had widely anticipated that the FOMC would overwhelmingly agree to a quarter-point rate hike amid cooling inflation and the slowing of the US economy.
Financial markets closed higher on February 1 after a volatile session. The US dollar index, which measures the greenback against a basket of currencies, fell 0.25% to below 102. The US Treasury market was mixed, with the 10-year benchmark yield declining by nearly 5 basis points to about 3.42%.
“Those hoping for a change to the phrase ‘continuous hikes’ are disappointed that the Fed is not yet ready to signal an imminent end to the hike cycle,” wrote prominent economist Mohamed El-Erian in a tweets.
What is the future of the Federal Reserve?
Following the FOMC announcement, US rate futures predict an 85% chance of a quarter-point hike at next month’s policy meeting. There’s also a 15 percent chance of a fare break.
While economists and market analysts have said it may be time to hit the pause button to determine how 15-year high interest rates are affecting the broader economy, Federal Reserve officials are discussing how much the federal funds rate should rise, especially as the institution nears the end of its quantitative tightening cycle.
Since November 2022, investors have fought the Fed, insisting that the central bank will reverse course and start cutting rates by the end of the year in response to slowing economic conditions. However, Fed Chair Jerome Powell has repeatedly said that the summary economic projections (SEP) are a better indicator of where the key rate could go in 2023.
According to the SEP, policy makers had expected the average rate to be 5.1% this year.
Many rate-setting FOMC members have argued that it is too early to tell that inflation is over.
Speaking during a recent interview with the Associated Press, Loretta Mester, president of the Federal Reserve Bank of Cleveland, said the central bank must go ahead and raise the main policy rate to at least 5%.
Esther George, outgoing president of the Federal Reserve Bank of Kansas City, told Reuters that interest rates need to rise more, although she would be happy with smaller hikes.
“People’s expectations about inflation are starting to fall. So I feel comfortable starting that gradual process… I would be happy to do 25 laps [basis points] if you were there,” he said. “We still have an upside risk to inflation. I don’t think I’ve reached a point where I think it’s clearly falling. There are enough problems out there to say we need to watch out for them.
Whatever course of action the central bank takes, Fed Vice Chair Lael Brainard said in a speech at the University of Chicago Booth School of Business last month that policy makers need to keep rates high for an extended period.
“Even with the recent moderation, inflation remains high and policy will need to be tightened enough for some time to ensure inflation returns to 2% on a sustained basis,” Brainard said. “The FOMC moved policy into tightening territory at a rapid pace and subsequently reduced the pace of target range hikes at its most recent meeting. This will allow us to evaluate more data as we move the policy rate closer to a sufficiently restrictive level, taking into account the risks related to our dual mandate targets.”
A look at the data
In December 2022, the annual inflation rate fell to 6.5% and the core Consumer Price Index (CPI), which excludes the volatile energy and food sectors, fell to 5.7%.
The Personal Consumption Expenditure (PCE) price index, the Fed’s preferred inflation gauge, also fell to 5% year over year in December 2022. The main PCE price index fell to 4.4 %.
Various economic parameters have not been inspiring. Personal spending decreased by 0.2% in December 2022, while personal income increased by 0.3%. Federal Reserve Bank manufacturing indices in Kansas City, Dallas and Richmond all remained in contraction territory. The Conference Board Leading Economic Index (LEI), which is considered one of the leading indicators of recession, fell by a faster than expected rate of 1% in December 2022.
In its first forecast for the first quarter of 2023, the GDPNow model estimate from the Atlanta Fed Bank suggests growth of 0.7% in the upcoming January-March period.