There is a lot of discussion about how slowing the fed interest rate hike could affect the economy. The stock market is rallying at the hints of smaller rate hikes, and the Fed is trying to convince people that inflation is declining. But when the Fed starts tightening monetary policy, it may actually lead to a recession.
US Federal Reserve Hiked Interest Rates
The US Federal Reserve Fed Interest Rate Hike to combat soaring inflation and to slow the economy. The hike comes after years of near-zero interest rates. The hike was expected to bring the benchmark federal funds rate to 4.25% – 4.5%. But the Fed has hinted at smaller, more gradual rate hikes. The markets are responding, with stocks bouncing back.
The S&P 500 closed the year on a high note, rising by 1% in afternoon trading. It closed in the green for the first time in almost a month. However, the Dow Jones Industrial Average is down 1.7% for the week. In addition, international stock markets are on the rise, fueled by optimism for the global economy.
Economy Showing Signs of Improvement
Inflation has been a major headwind for stocks. But with the economy showing signs of improvement, the Fed Interest Rate Hike may need to keep rates high for a while. The Fed has said the rate hikes will continue as long as inflation remains elevated.
Tightening Monetary Policy
One of the biggest worries among investors right now is how tightening monetary policy can cause a recession. The Fed continues to hike interest rates and that, according to several experts, is not helping the economy.
The market expects the Fed to continue raising interest rates and that it will raise them further in December. The Fed has raised its benchmark federal funds rate by 75 basis points this year, which is the biggest change since 1980.
Borrowing & Investment
The rise in Fed Interest Rate Hike has a direct impact on borrowing and investment throughout the economy. Businesses will likely slow down or cut investment in the face of higher borrowing costs. This could put a dent in the job market.
Changing monetary policy also has effects on prices and aggregate demand. Changing the Fed’s rate can make borrowing and saving more expensive, making the purchasing power of consumers weaker. This may cause firms to cut investment, resulting in recessions.
Curb Stubbornly High Inflation
A major question facing the Federal Reserve is whether to keep raising interest rates and attempting to curb stubbornly high inflation. The bank’s official target is to keep inflation below two percent, but in recent years, it has been stuck at higher levels than that.
Central Bankers OFF Guard
The rapid rise in prices has caught many central bankers off guard. They aren’t used to seeing inflation soaring past the 2 percent goal.
As a result, the Fed Interest Rate Hike has been stepping up its rate hikes, starting in March of this year. It’s now hiking interest rates in 0.75-point increments. It plans to raise its federal funds rate to 5.25% in 2023.
While the Fed is trying to bring inflation under control, some economists say it will take a bit longer than the Fed expects. They argue it will require a slower economy, which means less spending and less growth.
Measure of Annual Inflation
The Fed’s preferred measure of annual inflation is expected to fall from 6% in October to 5.6% by the end of the year. Inflation in Britain, too, eased from a 41-year high of 11.1% in October.
Couple of Positive Surprises
Fed Chair Jerome Powell has admitted that his central bank is “playing safe” by guessing when inflationary spirals might happen. He said that the economy is still out of balance and that he needs to see “couple of positive surprises” in inflation readings before he can be confident that inflation is declining.
The Federal Reserve’s target for inflation is an average annual rate of two percent. That target is not easy to maintain. Inflation expectations are influenced by several factors, including short-term interest rates and monetary policy tools.
During the 1970s and 1980s, the Fed raised interest rates ahead of inflation. They lowered them during the early ’90s recession. That led to a sharp acceleration in inflation.
Today’s Fed is slower to act than the inflationary Fed of the 1970s. It has signaled a willingness to slow rate hikes as the economy cools. However, many economists say that the Fed won’t be quick to cut rates.