The Federal Reserve raised its benchmark interest rate by half a percentage point on Wednesday, the most aggressive step yet in its battle against high inflation.
The central bank indicated that it will begin to reduce assets on its balance sheet as a result of the move higher in rates. The Fed had been buying bonds to keep interest rates low and money flowing through the economy, but the surge in prices has necessitated a dramatic rethink in monetary policy.
The Fed will allow a capped amount of proceeds from maturing bonds to roll off each month while the rest is reinvested, as part of the plan outlined Wednesday. $30 billion of Treasurys and $17.5 billion of mortgage-backed securities will roll off on June 1. The cap for Treasurys will increase to $60 billion after three months.
There were some expectations that the increase in the caps would be more gradual, but the numbers were mostly in line with the discussions that took place at the last Fed meeting.
Markets have been volatile throughout the year. The Fed has been an active partner in making sure markets function well, but the inflation surge has necessitated tightening.
Treasury yields retreated from their earlier highs after the announcement.
The central bank is expected to raise rates aggressively in the coming months, with a possible 75-basis-point hike on the table for June. The rate hike will push the federal funds rate to a range of 0.05%-1%, and current market pricing shows the rate rising to 3% by the end of the year.
The markets are a little bit more aggressive than we are. We think inflation is close to peaking and that another 50-basis-point increase in June is likely. If that shows some signs of peaking later in the year, that gives the Fed a little wiggle room to slow down.
The statement noted that economic activity was down in the first quarter, but that household spending and business fixed investment remained strong.
The government's attempts to address the situation were addressed in the statement.
Supply chain disruptions are likely to be worsened by the COVID-related lockdowns in China. The statement said that the Committee is attentive to inflation risks.
The Federal Open Market Committee's move received unanimous support despite some members pushing for bigger rate hikes.
The 50-basis-point increase is the biggest hike the rate-setting committee has made. The internet bubble and excesses of the early dotcom era were fought by the Fed. The circumstances are different this time.
The Fed slashed its benchmark funds rate to a range of 0.05% to 0.05% in early 2020 as a result of the crisis and then doubled its balance sheet with a program of bond buying. A series of bills injected more than $5 trillion of fiscal spending into the economy.
The policy moves came at a time when supply chains were in trouble. The Bureau of Labor Statistics shows that the consumer price index rose 8.5% in March.
Fed officials had to rethink their position after they dismissed the inflation surge astransitory.
The funds rate could rise to just 1.9% this year, after the FOMC approved a 25-basis-point increase in March. Multiple statements from central bankers pointed to a rate well north of that. It was the first time since June 2006 that the Fed has boosted rates in consecutive meetings.
The stock market has fallen through the year, with the index off 9% and bond prices falling. The benchmark 10-year Treasury yield was around 3% on Wednesday, a level it hasn't seen in over a year.
When the Fed last hiked the funds rate, it took the rate to 6.5% but was forced to retreat just seven months later. The Fed slashed the funds rate all the way down to 1% by mid-2003 because of a recession and terrorist attacks.
Some economists worry that the Fed could face the same dilemma as last time, failing to act on inflation when it was surging then tightening in the face of slowing growth. The GDP fell in the first quarter, though it was held back by factors such as rising Covid cases and a slowing inventory build that are expected to ease through the year.
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