Fed approves 0.75-point hike to take rates to highest since 2008 and hints at change in policy ahead

Wednesday’s Federal Reserve approval of a fourth quarter-point interest rate hike was signaled by a possible change in its approach to monetary policy.

Markets had been anticipating this move for weeks. The central bank increased its short-term borrowing rates by 0.75 percent to a range of 3.75%-4.4%. This is the highest level since January 2008.

This was the fastest pace of monetary policy tightening in the 1980s. Inflation has never been this high since then.

Markets were also anticipating the rate rise and looking for language that would indicate that this might be the last 0.75-point or 75 basis point move.

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The Fed’s new statement suggested that they would change their policy. It stated that future hikes will be determined by the Fed taking into consideration the cumulative tightening of the monetary policy, the lags in which monetary policies affect economic activity and inflation, as well as economic and financial developments.

Economists believe this is the “step down” in policy, which could lead to a rate rise of half a percentage point at the December meeting, followed by a few smaller increases in 2023.

Policy path changes

The statement this week expanded on the previous language, simply stating that “ongoing increases within the target range” will be appropriate.

“The new language stated that the Committee expects that continued increases in the target range are appropriate to achieve a stance in monetary policy sufficiently restrictive to return inflation over time to 2 percent.”

Initial stock prices rose after the announcement but then fell during the news conference by Chairman Jerome Powell. The market was trying to determine whether the Fed can adopt a more restrictive policy, which would allow for slower rate increases to reach its inflation goals.

Powell denied that the Fed might be slowing down, but he stated that he expected to have a discussion at the next meeting about slowing down tightening.

He reiterated his belief that inflation can be controlled with determination and patience.

He stated that “We still have a lot to do and the incoming data from our last meeting suggests a higher level of interest rates than we had previously anticipated.”

Powell reiterated the notion that rate increases may slow down in the future. This was something Powell has stated at recent news conferences.

“So that time is approaching, and it may arrive as soon as you next meeting or one after that.” He said that no decision had been made.

Soft-landing path narrows

The chairman expressed some pessimism regarding the future. He stated that the Fed’s “terminal rate”, or the point at which it stops raising rates, is now expected to be higher than the September meeting. The possibility that Powell spoke of a “soft landing” by the Fed is also present with higher rates.

“Has it narrowed?” He answered a question on whether the path had narrowed to the point where the economy does not enter a contraction. Is it still possible to do so? Yes.”

He said that the work is more difficult because of the requirement for higher rates.

Powell stated that “Policy must be more restrictive and that narrows down the path to soft landing.”

In addition to the change in the statement, Federal Open Market Committee once again classified growth in production and spending as “modest”. It also noted that “job gains” have been “robust in recent months” and that inflation is “elevated.”

Recent inflation readings indicate that prices are still at their 40-year highs. This rate hike comes as a result. The Fed is trying to reverse this trend by tightening its money supply.

There are growing concerns that the Fed will also pull down the economy’s ability to pay its living costs. Powell stated that he sees a path towards a “soft landing”, which is a situation in which there isn’t a severe contraction. However, the U.S. economy has seen virtually no growth this year, even though the full effect of the rate increases has yet to kick-in.

The Fed’s preferred inflation measure, which measures the cost of living, showed that the cost rose 6.2% in September compared to a year ago. This includes 5.1% for food and energy. The GDP fell in the first and second quarters. This is consistent with a definition of recession. However, it rose to 2.6% in quarter three, largely due to an unusual increase in exports. Housing demand has fallen as 30-year mortgage rates rose past 7% in recent times.

Wall Street markets are rallying in anticipation of the Fed starting to ease back, as concerns grow about the longer-term effects of higher rates.

The Dow Jones Industrial Average

The stock market has gained over 13% in the last month due to an earnings season that was not as bad as expected and growing hopes for a refitting of Fed policy. The Treasury yields have also fallen from their highest levels since the beginning of the financial crisis. However, they are still high. Most recently, the benchmark 10-year note was at 4.09%.

It is unlikely that rate increases will stop anytime soon. Therefore, the expectation is for a slower pace. Futures traders see a close coin flip chance of a quarter-point rate increase in December, compared to another three-quarter-point move.

According to current market pricing, the Fed funds rate will rise to a high of 5% in the future before it ceases to increase.

The fed funds rate is the price banks will charge each other to overnight loans. However, it can also be used for multiple consumer debt instruments like adjustable-rate mortgages and auto loans.