The Fed raises interest rates and cuts its stock of bonds by $9 trillion in a double attack on high inflation in the United States

“Inflation is way too high and we understand the difficulties it is causing,” Fed Chairman Jerome Powell said in what he called a direct message to the American public. “We are moving quickly to bring it back down.”

As expected, the central bank is raising its benchmark federal funds rate to a range of 0.75% to 1% in what is expected to be a series of increases. The vote was unanimous.

It’s the second rate hike this year and the biggest since 2000. Powell also said further 1/2 point rate hikes are on the table at upcoming meetings.

“Central bankers want to convince Americans that while they can’t do much to ease price pressures this year, they shouldn’t expect high inflation to persist for years to come. “said Chief Economist Avery Shenfeld of CIBC Economics. “Riding more aggressively up front is part of that message.”

US stocks
DJIA,
+2.24%

SPX,
+2.33%

jumped after Powell ruled out bigger rate hikes in the future. Obligations
TMUBMUSD10Y,
2.937%

have changed little. Rising interest rates took a toll on US equity markets at the start of 2022 and raised questions about their ability to regain momentum.

The Fed aims to push its benchmark short-term rate to 2.5% or even higher by the end of the year after keeping it near zero for most of the pandemic. The bank cut rates after the virus outbreak in 2020 to shore up a depressed economy.

The Fed’s balance sheet, meanwhile, has doubled in size during the pandemic in a successful effort to drive down long-term interest rates. The goal was to help the economy by making it cheaper for consumers to buy a house or car or to get a loan for businesses.

Initially, the Fed plans to reduce its holdings by $47.5 billion per month. After three months, the Fed would increase up to $95 billion a month in asset cuts, a move that could drain liquidity from money markets for years to come.

The central bank’s statement after its regular two-day strategy session indicated greater concern about inflation, including the prospect that it may not yet have peaked.

Powell said Covid-related lockdowns in China could worsen supply chain bottlenecks that have prevented companies from getting enough materials and played a big role in the current episode of high inflation.

“The committee is very mindful of inflation risks,” the Fed statement said, the first time this line appeared.

The Fed’s easy money approach at the start of the pandemic, combined with massive government stimulus, contributed to soaring inflation, economists say.

the the cost of living has jumped 8.5% over the past year, according to the consumer price index. In comparison, inflation rose by less than 1.4% per year on average in the decade before the pandemic.

Another major contributing factor, analysts noted, is the global supply shortage after the United States and other countries began to recover from the pandemic.

Businesses were unable to cope with the sudden influx of demand fueled by government stimulus payments, as they could not obtain enough materials to produce all the goods and services customers wanted.

Either way, the Fed is now poised to move quickly to raise rates to try to slow demand and reverse the high tide of inflation.

Before the Fed’s announcement, financial futures markets predicted the central bank would raise its short-term rate to 3% by the end of 2022, above the Fed’s latest forecast of around 2.5%.

Investors also believed the Fed would raise rates by 75 basis points at its June meeting — the first increase of that size since 1994. But Powell poured cold water on that idea, saying the Fed should s stick to a rate of 1/2 point. hikes so far.

A growing number of economists and former Fed officials, however, worry that the central bank will probably cause a recession in the United States by raising rates so quickly to curb inflation. In the post-World War II period, the Fed never brought inflation down to such a high level without triggering a slowdown.

Powell and other senior Fed officials insist they can achieve a so-called soft landing, central bank jargon for reducing inflation while keeping an economic expansion intact.

“I think we have a good chance of restoring price stability without a recession,” Powell said, but he acknowledged that threading the needle “is not going to be easy.”

Overall, the economy has grown rapidly after a brief coronavirus-induced recession in the spring of 2020, driven by strong consumer spending. Although economic activity “declined slightly in the first quarter, the Fed said, “household spending and business fixed investment remained strong.”

Additionally, the tightest labor market in decades has helped the United States recoup nearly all of the 22 million jobs lost at the start of the pandemic and spawned the largest wage increase in four decades. This allowed Americans to spend more.

“Jobs gains have been robust in recent months and the unemployment rate has come down significantly,” the Fed said.

However, soaring inflation is beginning to undermine the economy.

Businesses and consumers are facing huge price increases and customers are starting to balk at paying extra. Homes, cars, electronics, and basic necessities like groceries and gasoline have become much more expensive.

Labor is also scarce and the Fed is increasingly worried that it will contribute to inflation.

The most pessimistic scenario is a wage-price spiral like in the 1970s, where workers, consumers and businesses all expect prices to keep rising, making chronic high inflation a self-prophecy. -director.

Fed leaders insist that the current situation has nothing to do with the 1970s and will bring inflation under control.

“We don’t see wage-price spirals now,” Powell said.

Futures markets seem to believe that the Fed will succeed. Bond futures failed to reach levels suggesting high inflation is here to stay.

The central bank’s objective is to slow the inflation rate to less than 3% by the start of next year. Its long-term objective is an average inflation rate of 2% to 2.5%.

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