Global Economy Briefs

Fed hikes rates by 50 basis points, the most in 22 years

May 04, 2022

Insights for What’s Ahead

• As expected, the Fed hiked interest rates by 50 basis points today, the largest one-month increase in 22 years. Chair Powell also noted that additional 50 basis point increases will be on the table for the next two meetings. The FOMC is not considering 75 basis point rate increases presently.
• As expected, the FOMC also detailed its plan for reducing the size of the Federal Reserve’s balance sheet – which will begin on June 1, 2022. The reduction will involve letting assets roll-off the balance sheet at an increasing rate over a three month period, eventually getting to $95 billion per month.
• Both the policy statement and Fed Powell noted that despite the most recent GDP release, the US economy is strong. US consumers and businesses are healthy and the Fed expects solid economic growth in 2022. There is no expectation of recession. However, the risk of recession is not zero.
• At present, the Fed’s goal is to move monetary policy from an accommodative stance to a neutral one. That neutral rate may be somewhere between two and three percent, or potentially a bit higher. However, if more restrictive rates are needed down the road to achieve price stability the Fed will not hesitate to implement them.
• Both the policy statement and Chair Powell cautioned about emerging supply side shocks associated with the war in Ukraine and new COVID-19 lockdowns in China. The Federal Reserve’s tools are designed to impact demand not supply. Thus, these and potentially other geopolitical and geoeconomics risks need to be monitored closely.
• We continue to expect the Federal Reserve to raise rates to two percent at some point this year - potentially sooner than later. Furthermore, we do not currently expect the US economy to slip into recession.

What Were the Fed’s Actions?

The Fed may front-load rate increases. FOMC participants voted unanimously to raise interest rates 50 basis points, effective May 5, 2022. The increase follows a 25 basis point hike in March 2022, and is the largest one-month rate hike seen since 2000. Additionally, Chair Powell noted that additional 50 basis point rate hikes would be on the table for the next two meetings. The Fed’s goal is to move interest rates to a neutral range (of perhaps two to three percent or a bit higher) quickly to help achieve price stability. However, Chair Powel did not rule out the possibility of raising rates further, if appropriate, into a more restrictive range. This decision will be made at a future date.

The Fed will begin to reduce balance sheetin June. The FOMC policy statement stated that Federal Reserve will begin to reduce the size of its balance sheet on June 1, 2022. The cadence of the reduction will start at $47.5 billion per month ($30 billion in Treasury securities, and $17.5 billion in agency debt and mortgage-backed securities) and rise to $95 billion per month ($60 billion in Treasury securities, and $35 billion in agency debt and mortgage-backed securities) after three months. Details about the duration of the run-off were limited, with the FOMC saying it “intends to slow and then stop the decline in the size of the balance sheet when reserve balances are somewhat above the level it judges to be consistent with ample reserves.”

What is the Fed’s Assessment of the Current Economic Environment?

Core economic activity remains strong. While economic activity edged down in the first quarter, the FOMC said that household spending and business fixed investment remained strong. The Policy Statement also noted that job gains remain robust and that unemployment has declined substantially. Chair Powel expects labor to supply to increase over time as people reenter the labor market and the demand for labor to moderate gradually. Thus, the extremely low unemployment rate seen today may rise somewhat.

The Fed is highly attentive to inflation risks. While demand does play a role in the current inflationary environment, supply-side shocks are also an important driver. Chair Powell said that it is possible that inflation may be leveling off or even peaking now, but it remains will above the two percent target rate. Inflation psychology, fortunately, does not appear to be a factor influencing prices yet. While short-term inflation expectations are elevated, long-term inflation expectations are relatively stable. Chair Powell noted that he does not see a wage-price spiral presently.

Risks remains elevated. Russia’s invasion of Ukraine creates uncertainty for the US economy. The conflict in Eastern Europe is creating additional upward pressure on inflation and is likely to weigh on economic activity. Furthermore, COVID-19 lockdowns in China could reverse some progress seen in smoothing out supply chains. Thus, inflation risks remain elevated and the situation could potentially worsen. This could complicate the Fed’s goal of crafting suitable monetary policy to achieve price stability, in our view. While Chair Powell stated that a path to a “soft” or “softish” landing exists, he also acknowledges that the risk of a recession remains.