On Wednesday, the Federal Open Market Committee (FOMC) raised the federal funds rate by 50 basis points (bps; 100 bps equal 1.00%) to a new range of 0.75%‒1.00%. This was widely expected by the market, and the vote was 10-0.
In speeches throughout April, Federal Reserve (Fed) policymakers stressed the need to get the federal funds rate back to the perceived neutral of 2.25%‒2.50% as quickly as possible. As such, consecutive 50-bp rate hikes are priced into the next several FOMC meetings and the federal funds rate currently is expected to end 2022 at 2.50%‒2.75%. The last time the Fed increased the funds rate by 50 bps at a meeting was in 2000.
Along with the rate hike, the Fed announced it will begin to wind down its balance sheet, a policy action colloquially known as quantitative tightening. Beginning on June 1 and phased in over three months, the Fed will allow a total of $95 billion per month to roll off its balance sheet, split between $60 billion in Treasuries and $35 billion in mortgage-backed securities. The framework was outlined in the minutes from the March 15–16 FOMC meeting and is an acceleration compared with the last time the Fed shrank its balance sheet, beginning in 2018. With regard to the Treasury run-off, the Fed will focus on Treasury coupons instead of Treasury bills.
At the press conference following the announcement, Fed Chair Jerome Powell acknowledged the need to raise the funds rate expeditiously to a broad range of neutral and that additional 50-bp rate increases were on the table for the next couple of meetings. When asked, he pushed back against the suggestion that the Fed may raise rates by 75 bps, noting it was not something the committee is actively considering. However, he stressed the need to prioritize lowering inflation and inflation expectations over further gains in employment, stating that the federal funds rate may rise above neutral if financial conditions have not tightened. Despite his firm intention to prevent a wage/price spiral, the market was calmed by Chair Powell’s comments, likely attributable to his preference for 50-bp rate increases over larger rate increases. Following the announcement, Treasury yields were lower, led by 2- and 3-year Treasury notes, and risk asset prices were higher.
The Fed began to signal its concern about the level of inflation in the U.S. economy in the fourth quarter of 2021 and has pivoted swiftly from easy monetary policy to tighter monetary policy now. The Fed’s preferred measure of inflation—the Personal Consumption Expenditures Index—shows that prices on all goods increased 6.6% year over year through the end of March and by 5.2% on a core basket of goods that excludes the more volatile food and energy segments.
Additionally, the labor market is strong with the March unemployment rate registering at 3.6%, which is approximately full employment. Chair Powell has expressed concern for several months now about the challenges in hiring and the subsequent wage growth fueling price increases. Today’s actions by the Fed are a step toward slowing the level of inflation—even if it’s required to hinder the job market in order to do so.