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The market’s late shift in expectations gave the Fed the opportunity for a 0.75% hike.
The Federal Reserve turned up the heat in its battle against inflation today, raising the fed funds target range by 75 basis points, the biggest hike in 28 years. More aggressive moves may follow, depending on how economic data evolves between now and the next Federal Open Market Committee meeting at the end of July. The new range rose to 1.5-1.75%.
The market had for all intents and purposes led the Fed to this point, as last week’s inflation news prompted a significant repricing and upward shift in rate expectations. While policymakers don’t like to follow the market, they would have been foolish not to take its cue. Chair Jerome Powell made a point to mention that voters had a similar reaction to the high Consumer Price Index reading from last Friday, but couldn’t change guidance because of the Fed’s quiet period: “It's unusual to get data very close to our meeting that would change the outcome.”
The Fed made major revisions to Summary of Economic Projections from just last March, pointing to higher inflation and unemployment and lower economic growth. Similarly, the new dot plot showed sharply higher short-term rates for 2022 and 2023 than before. Specifically, the median rate was 3.4% by December 2022 and 3.8% by the end of 2023. Projections for 2024 and in the longer run reflect that policymakers may need to reverse course fairly quickly once inflation is tamed.
All in all, the forecasts reflect a healthy dose of optimism that more forceful action by the Fed will be successful at corralling inflation and achieving a soft landing. Even with the projection of a rate of 3.8%, it still expects economic growth of 1.7% for the next two years. Powell described the desire of the FOMC to move monetary policy into a moderately restrictive stance by the end of this year, and to continue into 2023. But make no mistake about it, getting prices under control is the priority. Whether the Fed can pull this all off remains to be seen, however. In the meantime, faster and higher seems to be the new path for short-term interest rates.
In spite of the recent softness in the repo market and the record usage of the New York Fed’s Reverse Repo Facility (which has topped $2 trillion since early June), the Fed opted to keep the rate on the RRP at 5 basis points above the lower bound of the new range, putting it at 1.55%.