The Federal Reserve today unanimously decided to raise its short-term interest rate target by a quarter percentage point to a range of 3.75 – 4.00%, the first hike since mid-2023. The Fed made two key changes to the statement announcing its decision, declaring that “domestic spending has been resilient” and the rate hike “will support a timelier return” to the Fed’s 2% inflation target.
In the press conference following the meeting, Chairman Warsh emphasized the strength of the US economy and the potential for an acceleration of that growth have shifted the Fed’s focus to price stability and that inflation has been too high for too long.
What’s odd about the rate hike is that the Fed was making steady progress against inflation in the few years prior to the Iran War. The increase in inflation since then is due to a spike in energy prices. Going into this year the Fed’s “playbook” based on prior economic research was that when inflation moves up temporarily due to a negative supply shock (which is what it is experiencing now in the energy sector) the Fed should hold monetary policy steady, neither tightening nor loosening, until the supply shock runs its course. Yet now the Fed is instead hiking rates into a negative supply shock, even though higher short-term rates will do nothing to boost energy supply.
On top of this, the “dot plot” released after today’s Fed meeting suggests policymakers will raise rates one more time later this year, with two members signaling no more changes this year, twelve members projecting one more hike (of 25 bps), and four members forecasting two more hikes. We think one more hike is the most likely outcome, not only because of the dot plots but also because it is very unlikely the Fed will raise rates at the next meeting, which is within one week of the mid-term elections this November.
See more: Fed Watch: Finally, ‘Walkin’ the Walk’
