Fed Hikes 75 Basis Points Second Time, Signals Third Is Possible

(Bloomberg) — Federal Reserve officials raised interest rates by 75 basis points for the second straight month and Chair Jerome Powell said a similar move was possible again, rejecting speculation that the US economy is in recession.

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Policy makers, facing the hottest cost pressures in 40 years, lifted the target for the federal funds rate on Wednesday to a range of 2.25% to 2.5%. That takes the cumulative June-July increase to 150 basis points — the steepest since the price-fighting era of Paul Volcker in the early 1980s.

“While another unusually large increase could be appropriate at our next meeting,” that’s a decision that will depend on the data between now and then, Powell said during a press conference following a two-day policy gathering in Washington. Policy makers next gather Sept. 20-21; the two monthly readings on inflation and employment due before then will help determine the Fed’s next move.

Powell also said the Fed will slow the pace of increases at some point. In addition, he said officials would set policy on a meeting-by-meeting basis rather than offer explicit guidance on the size of their next rate move, as he has done recently.

The comments about a moderation in the pace of rate increases sparked a rally in US stocks as Powell spoke, with Treasury yields tumbling along with the dollar. But some economists were skeptical.

“We read Chair Powell’s press conference as more hawkish than the market’s interpretation,” Citigroup Inc. economists Andrew Hollenhorst and Veronica Clark wrote in a note to clients. Inflation readings excluding food and energy will “push the Fed to hike more aggressively than they or markets anticipate,” with a 75 basis-point move in September.

Investors currently see a 50 basis-point hike as the most likely outcome at the September meeting, according to pricing in interest-rate futures contracts.

The latest increase puts rates near Fed policy makers’ estimates of neutral — the level that neither speeds up nor slows down the economy. Forecasts in mid-June showed officials expected to raise rates to about 3.4% this year and 3.8% in 2023. Powell said those forecasts — which are above market expectations — were the best current guide of where the Fed was heading this year and into 2023.

What Bloomberg Economics Says…

While many are worried that the economy is verging on recession, Fed officials see the glass as half full, with the strong labor market allowing the economy to withstand rapid monetary tightening. Bloomberg Economics thinks there’s little chance that the Fed will pause its rate hikes later this year, as markets currently expect.

— Anna Wong, Yelena Shulyatyeva, Andrew Husby and Eliza Winger

Click here for the full note

“It’s clear the Fed wants to move away from offering concrete forward guidance considering elevated uncertainty,” said Robert Dent, a Nomura Securities economist. “I do not believe that’s a dovish innovation.”

The Federal Open Market Committee “is strongly committed to returning inflation to its 2% objective,” it said in a statement, repeating previous language that it’s “highly attentive to inflation risks.” The FOMC reiterated it “anticipates that ongoing increases in the target range will be appropriate,” and that it would adjust policy if risks emerge that could impede attaining its goals.

The FOMC vote, which included two new members — Vice Chair for Supervision Michael Barr and Boston Fed President Susan Collins — was unanimous. Barr’s addition to the board earlier this month gave it a full complement of seven governors for the first time since 2013.

Forceful Hikes

Criticized for misjudging inflation and being slow to respond, officials are now forcefully raising interest rates to cool the economy, even if that risks tipping it into recession.

Higher rates are already having an impact on the US economy. The effects are particularly evident in the housing market, where sales have slowed.

While Fed officials maintain that they can manage a so-called soft landing for the economy and avoid a steep downturn, a number of analysts say it will take a recession with mounting unemployment to significantly slow price gains.

The FOMC noted Wednesday that “recent indicators of spending and production have softened,” but also pointed out that job gains “have been robust in recent months, and the unemployment rate has remained low.”

Powell said that he did not believe the economy was in recession, citing a “very strong labor market” as evidence.

“Demand is still strong and the economy is still on track to continue to grow this year,” he said. That said, officials do want to deliberately cool activity somewhat.

“We actually think we need a period of growth below potential in order to create some slack so that the supply side can catch up,” Powell said. “We also think that there will be, in all likelihood, some softening in labor market conditions.”

Investors are watching to see if the Fed slows the pace of rate increases at its next meeting in September, or if strong price gains pressure the central bank to continue with super-sized hikes.

The US consumer price index rose by 9.1% in June from a year earlier, topping forecasts and hitting a fresh four-decade high. The price gains are eroding earnings and sowing discontent with the economy, creating challenges for President Joe Biden and congressional Democrats ahead of the midterm elections.

High inflation had briefly fueled speculation that the Fed would lift rates by a full percentage point this month. But those bets got dialed back after Fed officials voiced wariness and key readings on consumer expectations for future inflation were better than expected.

Central banks across the globe are engaged in a battle against surging prices. Earlier this month the Bank of Canada hiked rates by a full percentage point and the European Central Bank surprised with a larger-than-expected half-point move, its first increase in more than a decade.

(Updates with analyst reaction starting in sixth paragraph.)