Overnight, the Federal Reserve increased its fed funds rate for the first time since 2018 - as expected by 25bps to 0.25-0.50% - to counter rising inflation while giving a more hawkish outlook for interest rates this year and next year.
First, the Federal Open Market Committee warned ‘ongoing increases in the target range will be appropriate’ for the fed funds rate now.
One member, St. Louis Fed President Bullard, voted for a 50bps rate hike at the FOMC meeting. Further, Chairman Powell didn’t rule out 50bps increases in future if core inflation, currently above 6% for the consumer price index (CPI) doesn’t start returning to the Fed’s 2% goal.
Second, the FOMC revised its forecasts for interest rates significantly higher, implying that Fed hikes will be front loaded in 2022 and 2023 to bring inflation back towards its 2% target in 2024.
The median FOMC projection now anticipates seven 25bps rate rises this year - increasing interest rates further at each of the Fed’s remaining six meetings of the year - and another three-to-four 25bps hikes in 2023. This would bring the fed funds rate up to 2.75% by the end of next year. It would thus exceed the FOMC’s estimate of the long-run neutral level for fed funds at 2.25-2.50%, implying officials are aiming to make monetary policy restrictive to lower inflation.
Third, the FOMC shifted its economic forecasts.
Source: Bank of Singapore, Bloomberg.
Policymakers cut their estimates of GDP growth this year from 4.0% to 2.8%, in part due to the oil shock from Russia’s war with Ukraine, while raising forecasts for core inflation to 4.1% in 2022, 2.6% in 2023 and 2.3% in 2024. Thus, inflation is still seen exceeding the Fed’s 2% target in two years’ time.
Fourth, Powell signalled the Fed could give its plans for unwinding its pandemic quantitative easing as early as May. Reducing its balance sheet would also help lower inflationary pressure.
Given the Fed’s determination to cut inflation, we change our forecasts and now see seven hikes this year (from five increases before) while keeping our view of four hikes in 2023. This implies:
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