“The invasion by Ukraine by Russia is causing tremendous human and economic hardship,” the Fed said in its statement. “The implications for the U.S. economy are highly uncertain, but in the near term the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity.”
In the first interest rate hike since December 2018, the Fed raised rates from the 0% to 0.25% range to the 0.25% to 0.5% range. It also said it would be reducing the central bank’s $9 trillion balance sheet of Treasuries and mortgage-backed securities “at a coming meeting.”
In its financial projections, the Federal Open Market Committee predicts it will continue to hike rates at each of its six remaining meetings in 2022. The interest rate would hit 1.9% by that forecast. In 2023, the committee predicts several more rate hikes, which would bring the federal funds interest rate to 2.8% where it would stay until 2024.
Some members of the committee — unnamed in the report — speculated, however, that more than seven hikes in 2022 would be necessary.
“It’s clearly time to raise interest rates and begin the balance sheet shrinkage,” Fed Chair Jerome Powell said during a press conference following the release of the committee statement. “As I looked around the table at today’s meeting, I saw a committee that’s acutely aware of the need to return the economy to price stability and determined to use our tools to do exactly that.”
The Fed has been adamant, until recent months, that inflation was merely transitory, and that it would be patient in assessing how to raise interest rates. Data have continually shown over the past few months, however, that inflation is now at the highest level in four decades.
At its last meeting in January, the Fed all but promised that rate hikes would begin in March. It additionally stated definitively it would start tapering bond purchases by $30 billion.
The key for the Fed, most analysts say, is to maintain a balance and not raise rates too quickly. “They have an extremely difficult path to traverse — inflation is at 40-year highs, while economic growth is threatened by higher energy prices and potentially much higher interest rates,” said Chris Zaccarelli, chief investment officer at the Independent Advisor Alliance.
“The stock market is vulnerable to the dual threats of too-high inflation, which will put a damper on corporate profits and consumer demand, and too-high interest rates, which could cause a recession,” he said.
In a commentary, Scott Wren, senior global market strategist at Wells Fargo, wrote that the central bank should increase rates “at a pace and to a magnitude that will create a headwind for demand yet still allow the economy to keep growing,” which he admits is no easy task.
“Some have been arguing that the Fed is ‘behind the curve’ and should have started raising interest rates over the course of the last six to 12 months,” Wren wrote. “The Fed now finds itself in the unenviable position of having to battle higher-than-expected inflation during a global rise in geopolitical tensions that has further pushed already high energy prices even higher, along with a vast array of other commodities.”
Most experts believe investors have priced in the Fed’s rate hikes. Prior to the Fed’s announcement, Peter Boockvar, chief investment officer at Bleakley Advisory Group, said the bond market has already priced in about seven rate hikes of 0.25% each. Boockvar added that, even if Powell were to increase the federal funds rate at 0.5% each time, it “might not change where the December federal funds trades at as the destination might still be the same result.”
Boockvar predicts the Fed will hike rates again in May and June and begin its quantitative easing the following month. “The real change is the pricing in of another hike because of the dot plot reveal,” he told investors after the committee statement was released, noting several members seeing a total hike of 2% as appropriate this year.
The Fed has come under some fire for not taking an aggressive stance toward inflation earlier, but Powell explained he had his reason for keeping rates so low for so long. “We can’t blame the framework,” Powell said, defending his previous decision to keep rates low to hit a target 2% average inflation during the Covid-19 crisis. “It was a sudden, unexpected burst of inflation.”
In its report, the committee also noted that gross domestic product growth would slow and inflation increase compared with previous estimates. GDP growth this year was reduced from the 4% predicted during its December 2021 meeting to 2.8%, while the core personal consumption expenditures price index rose from 2.7% at the December meeting to 4.1%.
“In my view the probability of a recession within the next year is not particularly elevated,” Powell said, pointing to the tight labor market, high payroll growth, and strong household and business balance sheets. “All signs are that this is a strong economy and indeed one that will be able to flourish in the face of less-accommodating monetary policy.”