The last time the Federal Reserve raised interest rates half a point, Alan Greenspan was its chairman. Twitter did not exist, Google was not listed and the iPhone had not been invented, but there was a technological bubble in the markets that was overheating the economy. It was May 2000. The current Fed Chairman, Jerome Powell, was a partner at Carlyle, an investment firm. 22 years later, Powell has had to pull the same trigger and raise rates 0.5 points, which leaves them between 0.75% and 1%, due to runaway inflation.
Powell has delivered on the script. A rise of 0.5 points was taken for granted for weeks. The Fed already raised interest rates by 0.25 points in March. It was the first time since the pandemic broke out and the central bank flooded the market with liquidity.
Now, the Fed anticipates that successive hikes will be necessary, which Powell pegged at half a point in each of the next two meetings, which will take rates to 1.75%-2% already at the end of July. Those raises “will be on the table,” which is Powell’s way of saying that’s what he hopes to do if things don’t change. For central banks, being predictable has become an asset and they try to show the path they are going to take to avoid accidents. In fact, the stock market reacted with strong increases.
“Inflation is too high and we understand the difficulties that is causing,” Powell said, appealing directly to American citizens. “And we are moving decisively to lower it,” he added.
It is also time to reduce the gigantic balance of 9 trillion dollars and the Federal Reserve is already preparing for it, also as planned. It will start doing so on June 1 at a rate that will reach a maximum cruising speed of 95,000 million dollars per month, although in the first three months the purchases will be half that amount.
The Federal Reserve has a dual mandate: to achieve price stability and maximum employment. With inflation reaching 8.5%, the highest in four decades, and an unemployment rate of around 3.5%, in an area of historical lows, a rate hike was a given.
He knows in depth all the sides of the coin.
“Job creation has been strong in recent months and the unemployment rate has dropped substantially. Inflation remains elevated, reflecting pandemic-related supply and demand imbalances, rising energy prices, and general price pressures.
The accident of the contraction of the economy in the first quarter (due to the foreign sector and the variation in inventories) does not alter the landscape of an economy with rising prices and wages, strong consumption, solid job creation and difficulties in hiring workers. An economy that has also suffered the impact of the war in Ukraine, transmitted above all through energy prices, and the continuous bottlenecks in the supply chain, for example due to restrictions in China, factors also mentioned by the Fed in its statement this Wednesday.
More uploads on the horizon
Analysts expect that there will be yet another 0.5 point hike at the next Fed meeting in June and that the Federal Reserve will be moving rapidly half a point towards neutral interest rates, that is, neither slowing down nor encourage economic growth, around 2.5%. From there, the movements would be 0.25 points again. In its statement, the US central bank “anticipates that successive increases in the target range” of rates will be appropriate.
The doubt for some analysts is whether this tightening of monetary policy comes late, if the Fed is behind the curve and therefore has to raise half a point at once. In fact, the market has already arrived. 10-year US Treasury bond rates have risen above 3%, mortgage rates have also risen, and the dollar has risen to its highest level in 20 years against major world currencies.
The defenders of the Fed praise the way in which it injected liquidity during the pandemic and believe that it has been a deliberate decision to maintain stimulus as much as possible, although now, when the price storm breaks out, they have to take out the umbrella faster and raise the prices. rates from half to half a point, which withdraws or makes money more expensive and puts pressure on prices. They argue that runaway inflation is not the result of monetary policy, but of a series of external factors such as the war in Ukraine, rising oil prices, rising food prices or a shortage of chips.
All in all, core inflation, not including the most volatile products such as energy or unprocessed food, has already exceeded 5% and threatens to become entrenched. That is why some members of the Federal Reserve would prefer to go even faster with rate hikes.
Twenty-two years ago, when Greenspan raised rates by half a point, they went from 6% to 6.5%. It was the latest in a series of hikes that, along with the bursting of the tech bubble, ended up causing a recession. This time, the hike is only the second, and rates are still in a range of 0.75% to 1%. The challenge for the Federal Reserve is to keep raising them to contain prices without causing a recession.
Strong stock market rise
The US equity markets experienced their best day since May 2020 on Wednesday after the words of the president of the Federal Reserve, Jerome Powell. The S&P 500 index posted a rise of 3% with which it makes up for part of the falls accumulated in the year.
Investors don’t like interest rate rises, but somehow the market had already anticipated that rise and even feared something worse. Powell has indicated that the Fed plans to raise interest rates by another half point at each of the next two meetings, bringing them into a range of up to 2%. But when asked about possible increases of 0.75 points, as some investors feared, he has indicated that it is not something that the Fed committee is considering.