The Federal Reserve launched another sortie against the fastest inflation in four decades on Wednesday, approving the fourth straight supersized rate increase and signaling more increases were likely in the months ahead.
Fed officials agreed Wednesday to lift the benchmark federal-funds rate by three-quarters of a percentage point to a range between 3.75 and four percent, the highest since January 2008. This was what forecasters and financial markets had expected. This is the fourth consecutive raise of 75 basis points.
The Fed’s statement indicated more hikes ahead but appeared to leave room for the Fed to slow the pace of rate hikes at future meetings while the Fed watches for delayed effects of already enacted rate increases.
“In determining the pace of future increases in the target range, the Committee will 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,” the Federal Open Market Committee said.
Equity markets saw this as a softening of the Fed’s stance, pushing stock prices up in the immediate market reaction to the announcement. The dollar, which has strengthened against foreign currencies as interest rates have climbed, moved lower.
The information released at the conclusion of the November meeting of the Federal Open Market Committee did not include new economic projections. At the September meeting, the summary of economic forecasts showed nearly all Fed officials expect the benchmark to be between four percent and 4.5 percent by the end of this year, which would mean another rate increase at the December meeting.
Economists are divided on the size of the Fed’s next move. Analysts at UBS, Credit Suisse, Nomura, and Deutsche Bank have forecast another three-quarter of a percentage point rise. Analysts at Goldman Sachs, Morgan Stanley, and Bank of America see a half-a-point rise being announced at the December meeting. The prices of the fed funds futures, a derivative that allows traders to speculate on future Fed moves, imply about even chances of each size move.
Fed officials have been trying to send a message that they are determined to tame inflation in the near term. Many investors formerly were convinced that the Fed would change directions next year if the economy slumped, a move widely described as a pivot. In a series of speeches over the past few months—including Fed chair Jerome Powell’s press conference after the September meeting and his presentation at a monetary policy conference in Jackson Hole, Wyoming in August—Fed officials have pushed the market off of that view by making it clear that they are willing to accept a downturn if that turns out to be the price of bringing inflation back down to their two percent target.
Those efforts have effectively changed what market participants now mean when they say the Fed will “pivot.” That word now describes the Fed reducing the size of its rate hikes to half a percentage point, or 50 basis points, then to one-quarter of a percentage point before eventually halting the increases. Powell and others have warned the market against interpreting a slowdown as preceding an imminent reversal in rates or that the ultimate target rate where the Fed pauses increases will be lower.
“By reaffirming the September median policy rate path, repeating consensus FOMC views that risks to the outlook for inflation still reside to the upside, and emphasizing a willingness to err on the side of tightening to much over tightening too little, we think the Fed can be successful in pushing back against any interpretation that a slower pace of rate hikes implies a lower terminal rate or a quicker pivot to rate cuts. In other words, it is now about the destination, not the journey,” a team of Bank of America economists led by Michael Gapen wrote in a note to clients last week.
Prior to the September meeting, equity markets rallied following each of the Fed’s interest rate announcements this year as investors decided time after time that Powell appeared to be signaling a softer approach ahead. At his press conference in late September, Powell avoided giving that impression and the major stock indexes fell. October, however, saw a massive rally in stocks, with the Dow Jones Industrial Average having the best month since 1976 and the best October since 1901. Rising stock prices ease financial conditions, making the Fed’s tasks of tightening even more challenging. This is sometimes described as the market fighting the Fed.
Inflation began accelerating in March of 2021 as demand surged as the economy reopened and the Biden administration pushed through a new round of aggressive government stimulus.
Many have deservedly called the explosion of rapidly rising prices Bidenflation. On the campaign trail, Biden officials had claimed that Donald Trump had left the economy in “ruins” by “bungling” the response to the pandemic. In fact, the U.S. economy had fared far better than its peers in Europe and Japan, thanks in large part to the aid packages pushed through by the Trump administration and supported on a bipartisan basis in Congress. In order to claim credit for the recovery that was already underway—and, even more importantly, deny the Trump administration credit for the recovery—the Biden administration pushed through the $1.9 trillion American Rescue Plan stimulus package even though prominent Democrat economists such as Larry Summers were warning that it would cause the economy to overheat.
Even as inflation started to heat up, the Biden administration downplayed the risks.“There’s nobody suggesting there’s unchecked inflation is on the way. No serious economist,” Biden said in July of 2021. Inflation had pushed the Consumer Price Index up 5.4 percent compared with the prior year. One year later, prices would be up 8.5 percent above those levels, the fastest rate of inflation in decades.
A report from the Federal Reserve Bank of San Francisco published in March of this year confirmed that this fiscal expansion was partly responsible for pushing inflation so high. “Fiscal support measures designed to counteract the severity of the pandemic’s economic effect may have contributed to this divergence by raising inflation about 3 percentage points by the end of 2021,” economists Oscar Jordana, Celeste Liu, Fernanda Nechio, and Fabian Rivera-Reyes wrote.
Fed officials initially mistook inflation as likely to be a brief episode linked to what they called “transitory” factors, such as disrupted supply chains and a lower labor force participation rate. As a result, they kept interest rates low out of fear of killing off the recovery by hiking too early. This too contributed to inflation and likely encouraged even more deficit spending by allowing the government to borrow at extremely low rates. Now Fed officials recognize that this was an error and have been frantically raising rates in hopes of preventing inflation from becoming more entrenched in the economy.
Recent data indicate that the Fed’s efforts have so far had mixed results. The housing market, which is highly responsive to changes in interest rates because most homes are purchased with mortgages, has entered what builders and realtors say is a recession. The labor market, however, has shown few signs of regaining balance. Monthly job growth has been very high and the unemployment rate extremely low. This week, government data showed the ratio of job openings to unemployed persons rose back to 1.9-to-one, far above the normal rate of one-to-one. So the labor market remains extraordinarily tight.
The month-to-month inflation figures have not been promising. Inflation fell in April and again in July, only to rise again in subsequent months. Measures of underlying inflation have suggested that inflationary pressures remain extraordinarily strong and likely to persist. The Cleveland Fed’s nowcast of inflation for October sees the Consumer Price Index rising 0.76 percent for the month, which would be a big acceleration from the 0.4 percent recorded in September. It sees core inflation, which excludes food and energy prices, at 0.54 percent, slightly lower than the 0.58 percent in the prior month.
The American left has begun to push back against the Fed’s inflation battle. Senate Banking Committee chair Sherrod Brown (D-OH) recently wrote a letter to Jerome Powell warning the Fed against “over-tightening.” Former Fed economist Claudia Sahm recently called on Congress to pass laws to ‘rein in’ the Fed, arguing that “the Fed continues to raise interest rates aggressively, making it costly for Americans to defend democracy in Ukraine and threatening a recession.”
Powell will hold a press conference at 2:30 to discuss the Fed’s views of interest rates, the economy, and inflation. He is widely expected to attempt to express a firm commitment to bringing inflation down to the Fed’s target while leaving the door open to a downshift in rate hikes at future meetings.
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