With the recent Federal Reserve hiking the current interest rate by 0.75 percentage points for the fourth straight time, the fed funds rate is now at a target range of 3.75% - 4%. This is a stark contrast to the 0% that had been the rate for over a year during the pandemic. At six rate rises in a row, these are the sharpest interest rate increases the Fed has committed to since the 1980s. The recent hike was widely expected – however, what wasn’t expected was Chairman Jay Powell’s hawkish tone in the following press conference. During the conference, Powell stated twice how the Fed still has ‘some ways to go’ regarding its hikes, adding how the risks of doing too little far outweighed the risks of doing too much.
Well, what are these so-called ‘risks’? For some time, the Fed has faced the challenge of striking a balance between two unpleasant situations. On one hand, if they don’t raise rates high enough, they face the issue of the already high inflation spiralling out of control, which will further reduce the purchasing power of many consumers, affecting people from all walks of life, especially those who have already been struggling to make ends meet. You may ask why the Fed doesn’t just raise interest rates quickly to combat inflation? There comes a major issue with raising rates – borrowing money becomes more expensive, which reduces disposable income and limits the growth in consumer spending. We’ve already been witnessing this take place since the start of the rate hikes. However, this results in a decline in economic activity – and an overly aggressive rate hike could result in growth slowing sharply and giving way to a recession.
During the meeting, Powell implied that the path for a ‘soft landing’ (an ideal scenario where the Federal Reserve would hike interest rates just enough to bring inflation down without causing a recession) had seriously narrowed. This was a hawkish tone, with him signalling how bringing down inflation is a bigger priority than preventing a recession. This may come as a disappointment to any investors who hoped for a more dovish signal. It also means that all focus is now on the labour market – as long as inflation remains high, and the labour market remains hot, the Fed will need to keep hiking rates.
As high inflation has been persistent over the past few months, it is unlikely to fall by itself, and so a significant slowdown in the economy is the only thing that’s likely to bring it down. Does that mean we’re bound to experience the same situation as the 2008 Financial Crash? Far from it – with leverage within the US banking system at a low, nowadays banks are a lot better prepared and capitalised to withstand a significant economic downturn.
However, with external factors such as the war in Ukraine and China’s zero-Covid policy also still ongoing, the future remains to be as unpredictable as ever, paving the way for a very interesting time for the markets.