The US central bank is desperately trying to signal things are under control, despite letting inflation slip. The Federal Open Market Committee (FOMC) voted to make the largest rate hike in over 20 years. They won’t stop there, though, they hinted at similar hikes for at least the next two meetings this year. Quantitative tightening (QT) also finally got a start date, marking the end of easy credit for now.
The Fed Made The Biggest Rate Hike In Over 20 Years
The FOMC made the biggest hike to US interest rates in over two decades. They raised the Federal Funds rate by 50 basis points (bps), bringing the range between 0.75% and 1.00%. A 50 bps hike is also known as a “super hike,” and it’s double the usual pace of hikes. It was the most significant increase since 2000.
Similar Sized Rate Hikes Likely To Follow
The beatings will continue until inflation is under control — meaning much higher rates. Fed Chair Powell suggested 50 bps rate hikes are on the table for the next few meetings. They did outright state a 75 bps hike is off the table, likely making a few bears cry.
The neutral rate of interest is forecast between 2.50% and 2.75%, more than double the current rate. Though skipping to that level using 50 bps hikes could mean it’s hit before the end of the year.
The Fed To Shrink Its Balance Sheet and Tighten Lending Conditions
In addition to rate hikes, the Fed blessed us with details on its QT program, which now has a start date. It kicks off June 1st, and they’ll let their maturing bonds roll off their balance sheet. The reduction will be capped at $30 billion in government bonds per month. An additional reduction of $17.5 billion in mortgage-backed securities is also planned per month.
QT is designed to reverse the credit liquidity introduced by quantitative ease (QE). As the balance sheet shrinks, tightening credit conditions are expected. Which is a good thing when you’re trying to cool demand to reduce inflation.
None of today’s measures were unexpected, with a 50 bps hike and QT forecast by most economists. US inflation is at a 40-year high, so aggressive policy changes need to be rolled out to send a message. However, when the Fed is this far behind the curve it becomes difficult to send a message without causing a little mayhem.
There’s no way the neutral rate is between 2.5% and 2.75% in the modern economy. Maybe at steady state, but with inflation running 2X of that, I have to imagine interest rates would have to be much higher in order to shock inflation down to within the region that 2.5% becomes a sufficient deterrent for inflation-accelerating borrowing.