Fed Open to Higher Rates as Inflation Remains a Concern
Fed Open to Higher Rates as Inflation Remains a Concern

Fed Open to Higher Rates as Inflation Remains a Concern

The vast majority of Federal Reserve policymakers supported a decision to slow down the pace of interest rate hikes at their recent policy meeting. However, they also emphasised that controlling inflation was crucial in determining how much further rates would need to rise.

The meeting minutes indicated a compromise between those concerned about a slowing economy and those who believed inflation would persist. While policymakers agreed that rates would have to rise, they also agreed to make smaller-sized hikes that would allow them to adjust more accurately to incoming data.

Fed Open to Higher Rates as Inflation Remains a Concern
source: BusinessToday.com

According to the minutes, “almost all participants” agreed that a 25 basis points increase in the target range of the federal funds rate was appropriate. This move would enable the Fed to “determine the extent” of future hikes.

At the same time, participants recognised that inflation risks remained a key factor in shaping the policy outlook, and interest rates would need to stay elevated “until inflation is clearly on a path to 2%.”

Only a few participants at the meeting favoured a half-percentage-point increase, while others stated they could have supported it. In 2022, the Fed implemented several rate hikes of 75 and 50 basis points in an attempt to control inflation that had reached 40-year highs. The current policy rate of the central bank is between 4.50% and 4.75%.

What are the inflation risks in 2023?

According to Omair Sharif, the President of Inflation Insights, the minutes’ mention of inflation risks as a “key” to policy suggests that recent data, which has shown less progress than expected, may result in a higher projected stopping point for the federal funds rate.

This could lead to a higher projected year-end policy rate, possibly as high as 5.6%, compared to the median 5.1% “dot plot” projection in December.

Following the release of the minutes, bond yields and the U.S. dollar increased against a basket of currencies, while a modest rally in U.S. stocks ended.

Futures traders tied to the Fed policy rate increased their bets on at least three more quarter-percentage-point rate hikes at upcoming meetings, with contract pricing indicating a top federal funds rate range of 5.25%-5.50%. The yield on the 2-year Treasury note, which is most sensitive to Fed policy expectations, rose approximately 4 basis points from its level before the release to about 4.69%.

The Federal Reserve is slowing the pace of its rate increases and considering an endpoint, but uncertainties about the economy remain. Some participants believe there is an elevated risk of recession in the US this year due to a drop in consumer spending. Others, however, note that households have excess savings and local governments have budget surpluses that could help.

The labour market remains hot, businesses are confident, and inflation is above the Fed’s 2% target. Fed officials are attuned to the risk of having to do more to keep inflation falling.