The Fed raises rates again, continues tug-of-war with inflation

The Federal Reserve’s tug-of-war against inflation continued this week as the central bank again raised interest rates to ward off rising prices while crossing its fingers that it won’t wreck the economy by pushing joblessness to new heights.

As expected, the Fed chose to push its funds borrowing rate by a quarter percentage point – the 10th consecutive boost in rates – as it wrestles with stubborn inflation trends, a falling GDP, a potential U.S. debt default, a likely looming recession, and now even a surprise banking crisis. The move hiked the rates to a range of 5% to 5.25%, a number unmatched since 2007.

Fed raises rates. Is that it for now?

But it hinted Wednesday that it might be done fiddling with interest rates for a while – really its only weapon against inflation – and pointed to positive signs that its strategy of frequent rate hikes is working successfully. The central bankers took a wait-and-see approach toward future moves, after previously stating that more rate hikes would probably be needed.

“In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments,” the Federal Open Market Committee said in a statement.

When interest rates rise, mortgages, auto and business loans become more expensive. The hikes are intended to slow consumer spending and hiring and cool the economy. As demand softens, inflation normally declines as consumers begin spending less and businesses can’t raise prices without imperiling business.

Spending, hiring remain strong

The current economy has been problematic for the Fed because in spite of interest rate hikes, consumer spending and hiring has remained strong, though may be showing signs of slowing.

“Initial and continuing jobless claims dropped last week and core [consumer spending] numbers have remained flat since December hovering around 4.6%,” said Steven Rosbrough, advisor at Washburn Capital Management in Vero Beach, Florida. “If economic data support a softening in the economy, then we could see a halt in hikes by June and a possible cut by September.”

A rate cut by September Miya be optimistic, Rosbrough said given the current banking issues, but he said the Fed’s decision will be based more on economic factors than banking problems.

“Inflation must fall by over 50% to reach the 2% target,” he said. “It would not surprise me to see another hike in June and potentially July if the job market remains strong.”

The Fed ignored the banking crisis in its rate announcement, but FED Chairman Jerome Powell led with it at his afternoon conference, saying despite recent failures and problem signs, the banking system is “strong and resilient” and is showing signs of improvements since March and April.

Powell acknowledged “a meaningful change” in the Fed’s language about possible future rate hikes. In previous announcements the Fed said it “anticipates that some additional policy firming may be appropriate.” In Wednesday’s statement, it only said additional moves “may be appropriate.” Powell said no decision wears made on possible rate hike pauses.

“Predicting future rate hikes is tough,” said Samuel Park, founder of TechMaestro. “If the economy keeps improving and inflation stays in check, this might be the last hike.
Surprises are always around the corner in finance. Based on my experience, we should be ready for the unexpected.”

Banking turmoil cited

That unease in the market stems mostly from the recent banking turmoil that saw three large bank failures and possibilities or more.

“Interest rate increases should grow the net interest margin at banks since interest income on loans can lead the interest expense on deposits which typically lags,” said Brian Pillmore, founder and CEO at Visbanking, a bank information platform. “Unfortunately, the situation is more complicated at present since some banks went long on the yield curve for bonds and every increase in interest rates further depresses the price of their bonds.”

Pilmore noted many banks invested surplus deposits during the COVID-related stimulus programs.

“Combined with the lack of interest rate hedges on these held-to-maturity bonds and the fact that most of the deposits are ‘demand deposits,’ the banks are in a liquidity squeeze and, some, like Silicon Valley Bank, end up with an insolvency issue if they have to prematurely sell bonds for deposit redemptions.”

Yet Powell seemed to downplay serious repercussions from the current banking problems. He said the Fed is committed to “learning the right lessons,” from the recent “episodes.” He said the Fed is focused on price stability and attaining the 2% target inflation rate, perhaps by the end of the year, and achieving a “soft landing” of beating back inflation without pushing the country into recession. Nevertheless, he indicated no appetite to thinking about possible rate cuts in the future.

“The Fed clearly wants more time to assess whether inflation is truly retreating to the Fed’s target level, while the market is hopeful that the Fed will more quickly recognize the need for a rate reduction to respond to, or prevent, a more severe recession,” said Marty Green, principal at Polunsky Beitel Green, a Texas-based mortgage lender. “Unfortunately, it is unlikely that there is a Goldilocks rate that will address both concerns, so the Fed is letting markets know it will choose to stay the course to win the inflation fight before becoming overly concerned about a possible recession. But I believe the Fed would prefer to avoid yo-yoing rates too rapidly in response to transitory events, as it believes a predictable rate – even if elevated – is better for long-term stability.”

Still, some think the Fed actions have created instability and uncertainty.

”Our view is that the Fed was late to address the problem and now has overdone their rate hikes,” said Steven T. Nelson, CEO for Capital Insight Partners. “Defaults in the banks, cracks forming in commercial real estate and other signs suggest that the Fed should have stopped some time ago.”

Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at [email protected].

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Doug Bailey is a journalist and freelance writer who lives outside of Boston. He can be reached at [email protected].