The FED raised interest rates 0.50%, 50 basis points. The last meeting resulted in 25 bps now moving the Federal Funds Rate to 0.75 – 1.00%. This is the largest single interest rate increase since 2000 amidst the “higher than expected inflation.”
“Inflation is much too high and we understand the hardship it is causing. We’re moving expeditiously to bring it back down”Jerome Powell
Chairman Powell made it clear that their focus on controlling inflation, and will proceed to reduce the balance sheet in June. Markets reacted positively to the news, indicating the rate hike was within expectations. Crypto and all major stock indexes were down to start the day. Investors were surprised to learn that higher rate hikes are not in consideration over the next couple meetings.
Still, investors should be worried about shrinking GDP in Q1, -1.4%.
The Federal Funds Rate
The 50 bps rate hike will bring the new range of the federal funds rate to 0.75% – 1%. The Federal Funds rate is important for a number of reasons aside from the effect that it has on the stock market. The FED previously lowered the federal funds rate to 0% – 0.25% 2 years ago in a response to the COVID outbreak.
This rate will effect consumers directly as the short term implications include short-term interest rates on things like home and auto loans, and of course credit cards. Below you can see the federal fund’s rate since 2000.
The next FOMC meeting is June 14 – 15 and the plan is for another 0.50% rate hike as they attempt to suppress and control the “sudden spike in inflation” that they “did not expect”.
Additionally, the next couple of meetings should include 0.50% rate hikes. Anything above 0.50% is currently not on the table or being actively considered. The target for the end of the year is currently around 3%.
Plans for Reducing The FED Balance Sheet
The FOMC is going to start the runoff in June. This is reducing the holdings of US Treasuries, and mortgage backed securities (MBS) amounting now to ~ $9T. In other words, quantitative tightening, QT. The last two years we have seen quantitative easing, QE, in the form of the FED buying more than $4T in assets, mostly treasury bonds and MBS.
50 bps rate increases and reducing the balance sheet is the “double barrel” strategy they have to fight inflation. Fed officials stated the plan to reduce the holdings of treasury bonds and MBS. Starting on June 1, the plan is to roll off no more than $30B in Treasury bonds and no more than $17.5B in MBS for the first 3 months. After which, no more than $60B in Treasuries and $35B in MBS.
We’re currently in an inflationary crisis, and people are struggling to navigate the situation, as Powell addressed in his opening statements. Supply chain “bottlenecks”, new COVID lockdowns in China, and ongoing economic sanctions from the Russia/Ukraine crisis are exacerbating international trade.
Economic growth expectations have also been slashed for the rest of the year. Expectations were set at 4.0% GDP at the start of the year cut down to 2.8% at the time of the FOMC in March. Just last week, reports came out that US GDP dropped 1.4% in the first quarter. First drop since 2020. The US is seeing both record high inflation and a shrinking economy, fun times.
The FED approved an increase of 50 basis points interest rates for the first time in 22 years. A small change that is looking to be the first of many interest rate hikes. Jerome Powell and the FED are tasked with maintaining low unemployment (currently at 3.6%) and decreasing the FED balance sheet of US Treasuries and MBS.
There are 5 more meetings ahead, with next one scheduled June 14 & 15. Chances are another rate hike of 50 bps and the commencement of balance sheet reduction.
Remember the FED and the Treasury have also been tasked with plans for a CBDC, a US Digital Dollar.