Federal Reserve on Wednesday increased base interest rates by another three-quarters of a percentage point and indicated that it would continue to grow well above current levels.
In an effort to reduce inflation, which is nearing its highest level since the early 1980s, the central bank raised the federal funds rate to a range of 3%-3.25%, the highest level since early 2008, after a third consecutive 0.75 percent move points.
The stock gave up earlier gains after the announcement, the Dow Jones Industrial Average fell more than 200 points. Traders were concerned that the Fed was remaining more hawkish for longer than some expected.
The increase, which began in March and from a point close to zero, marks the Fed’s most aggressive tightening since it began using the overnight rate as its main policy tool in 1990. The only comparison was in 1994, when the Fed raised a total of 2.25 percentage points; it will start reducing rates by next July.
Along with the big rate hike, Fed officials signaled intended to continue rising until the funds rate reaches the “terminal rate” or end point of 4.6% in 2023.
The “dot plot” of expectations of individual participants does not point to a rate cut until 2024 Fed Chairman Jerome Powell and his colleagues have stressed in recent weeks that rate cuts are unlikely to happen next year as the market shapes prices.
Members of the Federal Open Market Committee say they expect rate hikes to have an impact. The rate of funds on his face addresses the rates that banks charge each other for an overnight loan, but it trickles down to many adjustable-rate consumer debt instrumentssuch as home loans, credit cards and auto financing.
In their quarterly updates of rate estimates and economic data, officials rallied around expectations that the unemployment rate would rise to 4.4% by next year from the current 3.7%. Growth of this magnitude is often accompanied by recession.
However, they see GDP growth slowing to 0.2% in 2022, picking up slightly in subsequent years to a longer-term rate of just 1.8%. The revised forecast is a sharp cut from the 1.7% estimate in June and comes after two straight quarters of negative growth, the accepted definition of a recession.
The increase also comes on hopes that headline inflation will ease to 5.4% this year, as measured by the Fed’s personal consumption expenditure price index, which last showed inflation at 6.3% in August. A summary of economic projections shows that inflation will return to the Fed’s 2% target by 2025.
Core inflation, excluding food and energy, is expected to fall to 4.5% this year, little changed from the current level of 4.6%, before eventually falling to 2.1% by 2025 ( PCE readings were well below the Consumer Price Index.)
The decline in economic growth came despite the FOMC’s statement in July describing spending and output as “softened.” In a statement at the meeting, it was noted that “recent indicators point to modest growth in spending and production.” These were the only changes to the statement that received unanimous approval.
Otherwise, the statement continued to describe job gains as “strong” and noted that “inflation remains high.” The statement also reiterated that “a continued increase in the target rate would be appropriate.”
The dot plot showed that almost all participants have higher rates in the near term, although there has been some variation in subsequent years. Six of the 19 points favored a rate hike next year in the 4.75%-5% range, but the central trend was to 4.6%, which would put rates in the 4.5%-4.75% range. The Fed is targeting its funds rate in the quarter-point range.
The chart shows as many as three rate cuts in 2024 and four more in 2025 to bring the long-term funds rate down to an average forecast of 2.9%.
Markets are bracing for a more aggressive Fed.
Traders fully appreciated the price by 0.75 percentage points and even assigned an 18% chance of a full percentage point move, according to CME Group data. Futures contracts just ahead of Wednesday’s meeting pegged the funds rate at 4.545% through April 2023.
The moves come amid stubbornly high inflation that Powell and his colleagues dismissed as “transitional” for most of last year. Officials relented in March this year, raising rates by a quarter of a point, the first increase since rates were reset in the early days of the Covid pandemic.
Along with raising rates, the Fed is reducing the amount of bonds it has accumulated over the years. September marked the start of full-fledged “quantitative tightening,” as it’s known in the markets, with maturing bond yields of up to $95 billion a month allowed to leave the Fed’s $8.9 trillion balance sheet.