Fed approves 0.75 basis point hike to lift rates to highest since 2008 and hints at impending policy change

Fed approves 0.75 basis point hike to lift rates to highest since 2008 and hints at impending policy change

Equity markets rallied after the Fed hiked another 75 basis points

The Federal Reserve on Wednesday approved a fourth consecutive interest rate hike of three-quarters of a point and signaled a potential change in how it will approach monetary policy to reduce inflation.

U well telegraphed move which markets had expected for weeks, the central bank raised its short-term borrowing rate by 0.75 percentage points to a target range of 3.75%-4%, the highest level since January 2008.

The move continued the most aggressive pace of monetary tightening since the early 1980s, the last time inflation was this high.

Along with anticipation of a rate hike, markets were also looking for language indicating that this could be the last move of 0.75 points, or 75 basis points.

The new statement he hinted at that policy change, saying the Fed would “take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments” in determining future rate hikes.

Economists hope this is the much-talked-about policy “tapering,” and there could be a half-point rate hike at the December meeting, followed by several smaller increases in 2023.

Changes in policy

This week’s statement also expanded on previous language by simply stating that “ongoing increases in target range will be appropriate.”

The new language read: “The Committee anticipates that ongoing increases in the target range will be appropriate to achieve a monetary policy stance that is sufficiently restrictive to return inflation to 2 percent over time.”

Shares initially rose after the announcementbut it is ongoing Chairman Jerome Powell‘s press conference as the market tried to gauge whether the Fed thought it could implement a less restrictive policy that would include a slower pace of rate hikes to meet its inflation targets.

Overall, Powell dismissed the idea that the Fed might pause soon, though he said he expected a discussion at the next meeting or two about slowing the pace of tightening.

He also reiterated that determination and patience may be needed to reduce inflation.

“We still have some way to go and the data coming in since our last meeting suggests that the ultimate level of interest rates will be higher than previously expected,” he said.

Still, Powell reiterated that the time may come to slow the pace of rate hikes.

“So that time is coming, and it could come at the next meeting or the one after that. No decision has been made,” he said.

The soft landing path narrows

The chairman also sounded pessimistic about the future. He noted that he now expects the “terminal rate,” or the point at which the Fed stops raising rates, to be higher than it was at the September meeting. With higher rates comes the possibility that the Fed will not be able to achieve the “soft landing” that Powell has talked about in the past.

“Has it narrowed? Yes,” he said in response to the question of whether the road has narrowed to a point where the economy does not enter into pronounced contraction. “Is that still possible? Yes.”

However, he said the need for even higher rates makes the job more difficult.

“Policy has to be more restrictive, and that narrows the path to a soft landing,” Powell said.

Along with the changes in the statement, the Federal Open Market Committee recategorized consumption and output growth as “modest” and noted that “job gains have been strong in recent months” while inflation was “elevated.” The statement also reiterates that the committee is “very attentive to inflationary risks.”

The rate hike comes as recent inflation readings show prices remain near 40-year highs. A historically tight job market with nearly two openings for every unemployed worker is driving up wages, a trend the Fed is trying to counter as it tightens the money supply.

There is growing concern that the Fed, in its efforts to lower the cost of living, will also drag the economy into recession. Powell said he still sees a path to a “soft landing” in which there is no serious contraction, but the U.S. economy has shown almost no growth this year, although the full impact of rate hikes has yet to emerge.

At the same time, the Fed’s preferred measure of inflation has emerged cost of living up 6.2% in September compared to a year earlier – 5.1% even without food and energy costs. GDP fell in both the first and second quarters, meeting the usual definition of a recession, although it rebounded to 2.6% in the third quarter, largely due to unusual growth in exports. At the same time, the demand for residential buildings has fallen in 30 years mortgage rates rose over 7% the last days.

On Wall Street, markets rallied on expectations that the Fed could soon begin to step back as concerns grow about the longer-term impact of higher rates.

The Dow Jones Industrial Average has gained more than 13% in the past month, in part because of an earnings season that wasn’t as bad as expected, but also because of growing hopes for a recalibration of Fed policy. Treasury yields they also reached their highest level since the early days of the financial crisis, although they remain elevated. The the benchmark 10-year note the last one was around 4.09%.

There is little or no expectation that rate hikes will stop soon, so the expectation is only for a slower pace. Futures traders are pricing in an imminent coin toss for a half-point gain in December, versus another three-quarter point move.

Current market prices also indicate that the federal funds rate will peak near 5% before rate hikes stop.

The federal funds rate sets the level that banks charge each other for overnight loans, but it spills over into the more other consumer debt instruments such as adjustable rate mortgages, auto loans and credit cards.

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