The largest single-day interest rate hike since 1994 will boost interest on mortgages, credit cards, equity loans, and other rate sensitive products, but also shows the Federal Reserve, perhaps belatedly, is seriously attacking raging inflation.
Financial analysts, bankers, economists and others predicted the 0.75-percentage-point rate hike by the announced by Fed on Wednesday, particularly after last week’s announcement that Consumer Prices had ballooned unexpectedly. But they disagreed on whether the move will be effective and if it signals an overriding concern that the economy would slip into recession.
Fed sending 'a strong message'
“The Fed is attempting to send a strong message that it is serious about fighting inflation,” said Robert R. Johnson, chair and CEO of Economic Index Associates, a NYC-based firm that creates investable indices based on Fed monetary policy. “The problem is that if that message is too strong, the cure could be worse than the malady.”
Johnson said the Fed must ignore cries to get even more aggressive with raising rates.
“It can’t act too fast and stall the economy,” he said.
Still others said the Fed’s move amounted to a concession that it had been too timid with trying to rein in inflation.
Dan North, Senior Economist at trade credit insurer Allianz Trade, said he’s glad the Fed has “finally seen the light,” but believes it was long overdue.
“Aggressively raising rates will be the right thing to do since inflation is out of control and will be for some time since the sources of inflation are entrenched: too much easy money, a clogged supply chain and rising wages caused by a labor shortage,” he said. “The Fed is way, way behind the inflation curve since it takes 3–5 quarters for changes in monetary policy to take effect—they should have started a year ago.”
'Strong signal of a recession'
North predicted the Fed’s action today and likely subsequent hikes will invert the yield curve “sending off a strong signal of a recession in 2023.”
Others agreed, saying the likelihood of a recession was also raised along with interest rates.
“The Federal Reserve's misstep in raising interest rates too late means it will be difficult to tame the current high inflation without causing a recession,” said Charles Qi, CEO and founder at StockPick. “Its signal of aggressive rate hikes this year bodes ill for both the economy and the stock market. Investors should consider increasing cash holdings to protect against downside risks as well as tilting to value stocks which tend to outperform growth stocks in high inflation environments."
“The last time the Fed raised interest rates by 75 basis points was 1994, but in '94, it reacted early,” said Collin Plume, CEO of Noble Gold Investments. “They slowly raised interest rates, providing a cushion to both the supply and demand sides as they pulled both down slowly. Today, the Fed continued to pour water into our economic pool even when the supply was already drowning. This is going to be a crash and the destruction will take years to clear.”
“I feel that today’s move is an admission from the Federal Reserve that it was too loose and generous with its monetary policy in 2021 and are trying to reverse that quickly,” said Michael Ashley Schulman, founding partner and Chief Investment Officer at Running Point Capital. “The fact that the Fed is putting another 75-basis-point hike on the table for its July meeting is hinting to the world that Chair Powell is willing to follow Paul Volcker’s inflation fighting playbook from the 1980’s that pushed America into recession. But then, as now, whether higher interest rates will break inflation or lower energy prices will break inflation is really the debate.”
“It is clear in talking to mortgage company executives that the recent fluctuations in mortgage interest rates have increased the risks in an already challenging market and the belief that the sooner we get to a stabilized rate environment, even at elevated rates, the better it will be for the industry,” said Marty Green, principal at mortgage law firm Polunsky Beitel Green. “The belief is that it will also restore a level of predictability for consumers so that they can more comfortably make their financial decision on a potential move to a new home.”
Green said in an informal poll of his residential mortgage lending clients, showed a heavy preference toward an even larger rate increase, with some hoping for a full 100 basis point increase.
“Based on our conversations with clients, we believe many market participants will be pleased with the aggressive approach of the Federal Reserve, as there is some belief the Fed’s decision will more quickly bring stability to the home mortgage interest rate environment.”
Inflation 'a bigger problem'
“At this point, high inflation is starting to destroy corporate earnings and starting to depress consumer spending,” said Matt Nadeau, CFA wealth advisor at Piershale Financial Group, In Barrington, Il. “Put simply, inflation now is becoming a bigger problem than the rate hikes themselves, and the Fed had to at least show that they were going to take a strong stand in the fight against inflation. We believe the Fed is playing catch-up and the actions they are taking now may not be enough in the short-term to help avoid a recession.“
The Fed's three-quarter-point rate increase exceeds the half-point hike that Chair Jerome Powell had previously suggested was likely to be announced this week. The Fed's decision to impose a rate hike as large as it did Wednesday was an acknowledgment that it's struggling to curb the pace and persistence of inflation, which has been worsened by Russia's war against Ukraine and its effects on energy prices.
“Fed Chairman (Jerome) Powell reiterated that the employment market is too tight and inflation too high,” said Eric Merlis, managing director and co-head of global markets at Citizens Bank.
Merlis said in the Fed’s summary of economic projections core inflation has been raised to 4.3%, up from 2.7% back in December. Growth estimates have been cut from 4% in December to 1.7%.
“The market is pricing another 200 bps of additional Fed hikes this year, putting the funds rate at 3.75% by year-end,” he said. “The market is looking for 75 bps in July, 50 bps in September and November and 25 bps in December. The message from Powell is the Fed will fight inflation and is willing to sacrifice growth in order to get inflation lower.”
Borrowing costs have already risen sharply across much of the U.S. economy in response to the Fed's moves, with the average 30-year fixed mortgage rate topping 6%, its highest level since before the 2008 financial crisis, up from just 3% at the start of the year. The yield on the 2-year Treasury note, a benchmark for corporate borrowing, has jumped to 3.3%, its highest level since 2007.
Even if a recession can be avoided, economists say it's almost inevitable that the Fed will have to inflict some pain - most likely in the form of higher unemployment - as the price of defeating chronically high inflation.
Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at [email protected].
(Material from the Associated Press was used in this report).