Fed Relentlessly Chasing Inflation

The Fed Funds Rate decision was on expected lines, with FOMC hiking the rate by 75 bps. This takes the target range to 3.75% to 4%. The inflation has been running hot at 8% plus headline numbers for 7 consecutive months, a far cry from the Federal Reserve’s target of 2%. Fed has indicated that its target for inflation remains at 2.00% and that the measures intended to bring down inflation to its target levels will be undertaken as required.

Along with high inflation numbers, a tight job market has been one of the critical factors leading to US Fed maintaining its pace of rate hikes. Even as the headline GDP growth has slowed, a strong labour market is indicative of strong underlying demand which can potentially fuel inflation as well as inflationary expectations. In this context, Fed Chair Jerome Powell mentioned in his press statement that, “Despite the slowdown in growth, the labor market remains extremely tight, with the unemployment rate at a 50-year low, job vacancies still very high, and wage growth elevated. Reducing inflation is likely to require a sustained period of below-trend growth and some softening of labor market conditions.”

While the rate hike was expected, the Fed statement was keenly analysed for any indications of a potential pause or slowing the pace of rate hikes going ahead. The aggressive rate hikes by the Fed have given rise to fears of US economy going through a recession. The GDP numbers are indicating a slowdown, even as the Q3 2022 numbers were better than expected the preceding two quarters witnessed contraction. Given the rate of headline inflation and the state of the labor market, the US Fed may not pause at the current juncture but a slowing down of the pace of hikes may be warranted to ensure a soft landing. The Fed press release mentions that, “In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” This statement in the policy note had led to speculation that the Fed may be contemplating a moderated pace of hikes in its upcoming policies, but these hopes were quickly dashed in the press conference with, “Even so, we still have some ways to go, and incoming data since our last meeting suggest that the ultimate level of interest rates will be higher than previously expected.”

Since the policy meet, the expectations of the terminal Fed Funds Rate has moved to 5% to 5.25% as compared to the median expectation of 4.6% as per the dot plot provided post the previous policy meet. The impact of trajectory and pace of interest rate changes in the reserve currency is felt around the globe. With an endeavour to protect the currencies and limit the impact on the domestic inflation through imported route, major developed and emerging market policies may need to move in tandem with the US Fed.

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