What will the Fed do next

Key takeaways

  • The Fed raised interest rates by 25bps at its last meeting but analysts expect a 50bps increase this time.
  • Inflation is running hot with PCE, personal consumption expenditures, running 6.6% higher year over year in March.
  • Freddie Mac reported the interest rate on an average 30-year fixed-rate mortgage hovered around 5% last week.

The Federal Reserve Building in downtown Washington DC

Investors expect the Federal Reserve to strike a blow against inflation by raising interest rates following its two-day meeting Wednesday, May 4.   The Federal Open Market Committee, FOMC, is expected to approve a half percentage point increase, 50bps basis points, in the federal funds rate, which would be the single largest rate hike in more than 20 years.

Loretta Mester, President of the Federal Reserve Bank of Cleveland and a voting member of the FOMC, said two weeks ago, “I would support at this point given where the economy is, a 50bps rise in May and a few more to get to that 2.5% level by the end of the year.”

The FOMC raised interest rates in March a quarter percent, 25bps.  The statement said the Russian invasion of Ukraine created tremendous human and economic hardship and, “The implications for the U.S. economy are highly uncertain, but in the near term, the invitations and related events are likely to create additional upward pressure on inflation and weigh on economic activity.” 

The Consumer Price Index showed inflation running at 8.5% annually, the highest rate since the early 1980s.  The Fed’s preferred measure of inflation, personal consumption expenditures, or PCE, saw consumer prices rise 6.6% year over year in March.  Federal Reserve Chairman Jerome Powell said at the International Monetary Fund Spring Meeting late last month, “It is appropriate in my view to be moving a little more quickly.  I also think there’s something in the idea of front-end loading whatever accommodation one thinks is appropriate.”

The Fed has been accused of misreading inflation.  After its last meeting, the statement said, “the Committee expects inflation to return to its 2 percent objective and the labor market to remain strong.”  

St. Louis Federal Reserve Bank President James Bullard, a voting member of the FOMC, is pushing for a larger hike saying a 75bps increase “…can be done and the world doesn’t come to an end.”  Minneapolis Federal Reserve Bank President Neel Kashkari said, “We’re going to have to do more through our monetary policy tools to bring inflation back down” if supply chains remain constrained. 

Raising interest rates will impact the rates U.S. consumers pay on credit cards, car loans, and mortgages.  Last week Freddie Mac reported the interest rate on an average 30-year fixed-rate mortgage hovered around 5%.  A year ago, it was just under 3%

Some analysts worry an increase in interest rates could trigger a recession. Roger Ferguson, a former Fed Vice Chairman, told CNBC,  “A recession at this stage is almost inevitable, It’s a witch’s brew, and the probability of a recession I think is unfortunately very, very high because their tool is crude and all they can control is aggregate demand.”

The Commerce Department reported GDP in the first quarter contracted by -1.4% after growing 6.9% in the fourth quarter of 2021.  But Ferguson predicts a recession won’t hit until next year. 

Investors will focus on Chair Powell’s press conference after the Fed statement is released Wednesday to see if he hints at the size of potential rate increases at upcoming FOMC meetings later this year. 

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