Federal Reserve Hikes Rates by 75 Bps

Source: Lyn Alden

The Federal Reserve announced its third rate hike of 2022 to increase the benchmark interest rate from 1.00% to 1.75%. This is the first 75 basis point hike since 1994 as it continues to try to cool down inflation. Prior to the meeting, the market was expecting a 0.50% rate hike up until U.S. inflation report released on June 10th posted a higher than expected 8.6% increase. Once released, the market increased the expected rate hike to 0.75%.

It is looking less and less likely that Jerome Powell and the Federal Reserve will be able to navigate these difficult financial conditions and arrive at a soft landing as originally planned for this rate hike cycle. A “soft landing” would be considered a rate hike cycle that has a limited impact on the underlying economy and if there were a recession, it would be brief. The alternative “hard landing” is a longer and extended recession induced by additional aggressive rate hikes, like the one we saw today, to attack inflation numbers.

The primary reason why a soft landing is going to be so difficult is because of the amount of inflation currently driven by the supply side. When the Federal Reserve raises rates, it has an immediate impact on anything purchased through financing such as real estate, vehicles, expensive consumer goods, etc. However, what the Fed cannot influence is the amount of supply available. A perfect example of supply-driven inflation is the price of oil across the world right now. No matter how much rates increase, they will not change the price of oil until demand is significantly reduced. Demand reduction for something like oil would mean a serious cutback for the everyday individual, which is unlikely given the essential role it plays in all our lives. A reduction in demand at that level would mean a significant recession.

The Federal Reserve has forecasted that inflation will be at 5.2% by the end of 2022, which is still extremely significant, but a large improvement on what we are currently seeing.

The Fed’s next meeting is scheduled for July 27, 2022, where another 0.50% rate hike is expected, depending on economic conditions. The market is pricing in four more rate hikes this year which would put the target rate between 3.50% and 4.00%.