The Federal Reserve on Wednesday raised its main policy rate by 50 basis points, the largest increase since 2000. The steep hike reflects the current state of the US economy, where inflation surged to 8.5 percent in March with unemployment relatively low at 3.6 percent.
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“Inflation is much too high and we understand the hardship it is causing, and we’re moving expeditiously to bring it back down,” Fed chair Jerome Powell said at the beginning of his statement. “It is essential that we bring inflation down if we are to have a sustained period of strong labour market conditions that benefit all.”
US markets rallied after the Fed announcement and European markets were due to open higher on Thursday. European markets opened higher and then gave up some of their gains. The S&P 500 on Wednesday closed 2.99 percent higher while the Dow was up 2.8 percent.
“Inflation is also starting to back down somewhat, which is a good sign, but we are not on dry land yet,” said Philippe Gijssels, chief strategist at BNP Paribas Fortis. “Technology stocks are still in a downtrend. I see this more as a rally from a strongly oversold position. The Fed had little choice anyway, and I think the next decisions will be at least as important.”
Fed switched to QT from QE
Frank Vranken, CIO of Edmond de Rothschild Europe, said he believes the market rally will die out in the coming days, saying that equity investors remain bearish, while too many investors still are expecting a rebound. Furthermore, he noted that Powell stated that the economy is doing fine: households and companies have plenty of reserves while the labour market remains tight. “In other words, it is expected that there will be many more increases. But the most important point, and one which the markets rather underestimated, was the changes announced in relation to QT,” he said, referring to the Fed’s switch from quantitative easing, or QE, to quantitative tightening, known as QT.
The Fed on Wednesday also announced plans to reduce its balance sheet, whereas central banks in recent years have been running asset purchase programmes to expand their balance sheets. Like the Fed, the ECB is currently talking about ending its own asset purchase programme. The Fed said it will initially reduce the size of its Treasury holdings and agency mortgage-backed securities, or MBS, by 30 billion dollars and 17.5 billion per month, respectively. These caps will be doubled to 60 billion and 35 billion per month in September.
The Fed’s press conference focused on what the Federal Reserve will do for the rest of the year. For now, markets expect additional 50 basis point rate hikes at the Fed meetings in June, July and September, which means that policy rates will be around 2.5 percent after the summer.
Not ‘actively’ considering 75 basis points hike
Powell said a hike of 75 basis points is not “actively” considered. “A 75 basis point increase is not something that the committee is actively considering,” Powell said in response to a question at the press conference.
Powell cited two major threats to the world economy. The new Chinese corona lockdowns could exacerbate problems in the supply chains, while the war between Russia and Ukraine is adding to inflationary pressures.
“The surge in prices of crude oil and other commodities that resulted from Russia’s invasion of Ukraine is creating additional upward pressure on inflation. And COVID-related lockdowns in China are likely to further exacerbate supply chain disruptions as well.”
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