Fed Responds to Market Worries, Accelerates Rate Hikes

Central Bank Raises Interest Rates 0.75 Percentage Points, Largest Jump Since 1994

US Federal Reserve Chair Jerome Powell speaks at a news conference on interest rates, the economy and monetary policy actions, at the Federal Reserve Building in Washington, DC, June 15, 2022. (Getty Images)

The Federal Reserve’s policy-setting committee shifted gears on Wednesday and boosted its target lending rate by 75 basis points, or three-quarters of a percentage point, the highest uptick since 1994.

The decision sets the overnight target rate for banks to between 1.5% and 1.75%. This is the third rate hike in the Fed’s current tightening cycle, following the Fed’s initial 25-basis-point hike at its March meeting and a 50-point increase at its May meeting.

Until recently, the market had been largely expecting a smaller rate increase of 50 basis points, as was broadly transmitted by Fed governors in the lead-up to the meeting. But the latest inflation report released last Friday surprised market watchers when it showed prices accelerated by 8.6% in May over the year and inflation had reached a 40-year high, blindsiding most analysts who had expected inflation to have peaked the prior month.

With criticism mounting in the market of the Fed’s slowness to respond, the Fed’s move Wednesday appears aimed at quelling fears that inflation has become entrenched and demonstrating that the Fed is indeed committed to its price stability goal and returning inflation to its 2% target.

At his post-meeting press conference, Fed Chairman Jerome Powell insisted that the committee understands that inflation is uncomfortably high. He said that the committee will remain “nimble” in response to economic conditions that are evolving “in surprising ways.”

Several questions at the press conference focused on the speed with which the Fed changed its forward guidance in response to recent inflation reports, and whether that pivot eroded the Fed’s credibility. Powell insisted that the committee will move

“expeditiously” until it sees “clear and convincing evidence” that inflation is coming back down, which Powell de􀀂ned as a series of declining monthly readings of inflation.

In addition to rate hikes, the bank is continuing to trim its balance sheet of Treasuries and mortgage-backed securities, a process that began in early June. Taken together, the tightening action marks the Fed’s most aggressive stance in decades as it battles inflation.

Aggressive rate hikes, however, come with the risk of slowing down the economy too much and tipping it into recession. The economy contracted in the first quarter of 2021, with gross domestic product growth falling by 1.5% in the Commerce Department’s second estimate. This was largely due to a rundown of inventories after businesses stocked up in the second half of last year to get ahead of supply-chain disruptions, and a drop in net exports, as imports surged while exports fell.

Powell Wednesday reiterated the Fed committee's position that the economy is on a very strong footing given the strength of household spending. While business fixed investment is slowing, as is the housing market, the economy overall is still well-positioned to tolerate tighter monetary policy, he said. Powell noted that a similar rate hike of 75 basis points could be considered at the committee’s July meeting, bringing the federal funds rate higher to a more normal level and giving the Fed more options for future action, such as cutting rates if the economy slows more than desired.

In a separate note, the Fed released its updated Summary of Economic Projections, the forecasts of economic activity prepared by individual committee members. Compared to projections released in March, the median view of economic growth in 2022 was cut from 2.8% to 1.7%, and growth for 2023 from 2.2% to 1.7%. Inflation, as measured by the core personal consumption expenditures price index, is expected to be 5.2% over the year, a continued acceleration over the March forecast of 4.3%. The median view of the unemployment rate in 2022 was lifted to 3.7% from 3.5%, increasing to 4.1% in 2024 as the economy slows.