Federal Reserve Hints at Pause in Rate Hikes Amid Economic Uncertainty and Inflation Concerns

On Wednesday, the Federal Reserve raised its benchmark overnight interest rate by 25bps to the 5.00% - 5.25% range, marking the 10th consecutive rate hike in response to high inflation. However, Fed Chair Jerome Powell suggested that this may potentially be the last rate increase for a while, as the economy faces a potential slowdown and risks of a tough credit crackdown by banks.

Over the last ten meetings since March 2022, the Fed has raised the policy rate by a full 5 percentage points. Some believe this rapid pace may now warrant a pause to allow the impact of these increases to be fully felt. The Fed has removed the language stating that it "anticipates" further rate increases from its policy statement, but Powell noted that it is still an open question whether further hikes will be needed. He explained that policy decisions from June onward would be made on a "meeting-by-meeting" basis.

Inflation remains the central concern, as it currently stands at more than twice the Fed's 2% target. Despite this, Powell emphasized that it is too soon to say with certainty that the rate-hike cycle is over. He also dismissed market expectations that the FOMC would cut rates this year, saying such a move is unlikely. Instead, Powell argued that the committee's view is that inflation will take some time to come down and that it would not be appropriate to cut rates in the current context.

The Fed's policy rate is now roughly the same as it was before the financial crisis 16 years ago, and the majority of Fed officials projected in March that this level would be "sufficiently restrictive" to return inflation to the central bank's 2% target. However, the economy still faces several challenges, such as the possibility of credit tightening by banks, which may slow the economy more than expected, and risks surrounding a US debt limit standoff between Republicans in Congress and Democratic President Joe Biden.

Despite these potential headwinds, Powell remains optimistic about avoiding a recession. He noted that recent data on falling job openings and lower earnings growth, coupled with historically low unemployment, suggest that the economy could slow without a dramatic rise in joblessness. "The case of avoiding a recession is in my view more likely than that of having a recession," Powell said.

The shift in the Fed's approach was reflected in US interest rate futures, which showed broad expectations for no hikes at either of the central bank's next two policy meetings. US stocks initially held onto gains after the release of the Fed statement but fell later in the afternoon, and yields on US Treasury securities dropped sharply.

As the Federal Reserve navigates this new phase of post-pandemic economic recovery, it will continue to balance the need for controlling inflation with the potential risks to economic growth. With its recent policy adjustments, the Fed appears to be signaling a more cautious approach to future rate hikes, taking into account the evolving economic landscape and the potential impact of credit tightening on the broader economy.

Sources:

WSJ: https://www.wsj.com/articles/federal-reserve-raises-rates-signals-potential-pause-eb264784

Reuters: https://www.reuters.com/markets/us/fed-likely-hike-rates-hint-pause-tightening-cycle-2023-05-03/

Washington Post: https://www.washingtonpost.com/business/2023/05/03/fed-rate-hike-powell-banks/