As the economy struggles to cope with rising inflation and a growing risk of recession, the Federal Reserve has increased its interest rates by a staggering amount.
The Federal Open Market Committee met in Washington for two days and announced that the central bank would increase its target interest rate by three-quarters percent, or 75 basis point. This is the Fed’s third consecutive rate increase on that scale. It is an aggressive move that demonstrates the Fed’s determination to lower inflation.
In the last four months, Fed’s target interest rate has increased by 2.25%. This is the largest rate increase since the Great Inflation in the 1980s and 1990s. It is currently at 3% to 3.25 percent, which is the highest target since 2008’s financial crisis.
This 75-basis point increase follows a hotter than expected consumer price index report from August. It found that inflation fell to 8.3% in the 12 months ended August. This is a figure economists did not expect.
Some economists were so confident in the Fed’s ability to drive down prices even at the cost of the economy that they bet on a larger percentage point increase prior to Wednesday’s rate rise.
Officials also increased their inflation projections. Inflation is now expected to be 5.4% by the year’s end, as opposed to 5.2% in June’s projection. For 2023 and 2024, inflation projections were slightly higher than June.
The Fed also increased its projections for the future unemployment rate over the next months and years. The Fed now forecasts that the unemployment rate will rise to 3.8% by the close of the year, and 4.4% by 2024. This is an acknowledgement of the economic effects of its tightening.
The FOMC members heavily reduced the GDP growth projection for this year, from 1.7% in June to 0.2%. They also revised their GDP forecasts for next year and 2024.
Inflation has made almost every aspect of our lives more expensive, but food and energy prices have been the most difficult to afford. A gallon of gasoline in the United States costs on average $3.68. This is a 49-cent increase over last year. Gas prices fell from $5 to $5 earlier this summer, it is worth noting.
CPI measures food prices and has seen them rise beyond 8.3%. The average chicken price has risen by approximately 16% annually, while flour has gone up by 23.3%. The average price of eggs has risen by almost 40%, while milk has risen by 17%, butter has risen by 29%, margarine by 29%, and rice by 13%.
Since the August CPI report’s release, the stock market has been volatile and underperforming. Markets had their worst day in two years since the outbreak of the coronavirus pandemic, which shows how panicked investors feel that the Fed won’t be able “soft land” with success.
A soft landing is when the central bank under Powell will be able, without causing the economy into recession, to cool inflation to healthy levels. Although this prospect seemed more realistic a few weeks ago, the latest inflation report and other indicators indicate that it is not a realistic goal for the Fed.
Powell acknowledged that it will be difficult to engineer a soft landing and used his annual speech from Jackson Hole in Wyoming to temper hopes that the United States would be able avoid recessionary conditions. Powell warned that the Fed would continue to fight inflation, even though it may mean some pain for businesses and households.
The past two quarters saw negative gross domestic product growth. This is a pattern economists use to gauge the severity of past recessions. However, the current economic environment is different from previous recessionary periods because the labor market is tighter than ever and the unemployment rate is at its lowest level in years.
The Fed is increasing rates as usual this week. This is a warning sign that the economy is in recession. Despite the rate hikes, August’s employment numbers were higher than expected.
The economy added 315,000 jobs to its ranks in August. However, the unemployment rate climbed slightly to 3.7% in August, which is still below the low level it was before the pandemic.
Fed officials likely felt more confident about a 75 basis point increase due to the stronger job numbers. This shows that the economy is still strong enough to withstand the huge rate increases. The Fed’s rate hikes have been countered by declining jobless claims.
There are signs, however, that the Fed’s historical tightening cycle may be starting to crack the economy.
FedEx, the world’s largest shipping company, panicked last week when it pulled its full-year guidance. It warned that there is a global recession. It stated that it expected first-quarter earnings of $3.44 per share. This is far lower than the $5.10 average analyst estimate.
Raj Subramaniam, FedEx CEO, stated that he believes the economy is in a “worldwide depression.”
There are other signs emerging in the housing sector, which is usually the first to be affected when the Fed raises interest rates. This happens because mortgage rates rise, making it less affordable.
Both new and existing home sales have fallen rapidly, while other housing indicators such as housing starts or new permits for construction have, with some exceptions been falling due to higher mortgage rates. The index of market conditions for single-family construction, homebuilder confidence, has dropped rapidly and is now in decline.
Next meeting of the Fed will be held in November. The Fed will review a variety of economic reports, including labor market and inflation reports, to determine where the federal funds rates will go next.