The Federal Reserve hiked interest rates Wednesday in what is expected to be the end of its campaign, launched hurriedly last year, to counter historic inflation by increasing borrowing costs.
Following a two-day meeting of its Federal Open Market Committee in Washington, D.C., the central bank announced that it would be raising rates by a quarter of a percentage point.
The central bank’s key overnight rate will rise to a range of 5.25% to 5.5%. That is higher than it has been in decades. In 2006, amid the housing bubble, the Fed targeted a short-term rate of 5.25%. The last time it sought a rate as high as 5.5% was in early 2001, as the fallout from the collapse of the dotcom bubble began to work its way through the economy.
An overwhelming 97% of investors expected the quarter of a percentage point revision, according to futures contract prices for rates in the short-term market targeted by the notoriously predictable Fed.
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Recent reports show that inflation is meaningfully falling but the pause is a sign that the central bank still sees too-high inflation as larger threat to the economy than an economic slowdown. The decision follows more than a year of, at times very aggressive, rate hikes.
The June consumer price index report showed inflation fell to a 3% annual rate. That is down from as high as 9% last summer, when prices were being pushed up by both supply-side factors — most notably, higher energy prices caused by Russia's invasion of Ukraine — and by hot demand for goods and services spurred by high government spending and low interest rates.
At the outset of the Fed's efforts to bring down inflation via rate hikes, many economists feared that it would slow down commerce too much, and tip the economy into recession. Yet the labor market has remained robust, though has shown some signs of slowing in recent months.
Unemployment is historically low. The national economy added 209,000 jobs in June, according to the Bureau of Labor Statistics and the unemployment rate is hovering around 3.7% — near the ultra-low level it was at prior to the pandemic.
There is a growing likelihood that the Fed will be able to pull off an elusive “soft landing,” a scenario in which the central bank is able to tamp down inflation to a healthy pace while avoiding a recession. Just a few months ago, the prospect of a soft landing seemed highly unlikely.
Goldman Sachs Chief Economist Jan Hatzius recently put the odds of a recession in the next 12 months at just 20%, down from 25% the month before. The financial services giant previously pruned its forecast from the 35% level it announced in March amid the collapse of Silicon Valley Bank and turmoil in the banking system.
President Joe Biden has been cheering the positive economic developments and has embraced the data by branding it “Bidenomics,” a bid to shift public perception about his handling of the economy. Biden is still getting low economic approval numbers, although his campaign hopes that public perceptions will shift in the lead-up to the 2024 elections.
And it’s worth noting that consumer sentiment has been gaining. Consumer confidence index leapt to its highest level since July 2021, according to a report released Tuesday by the Conference Board. Additionally, inflation expectations pulled back to the lowest level since late 2020.
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“At the start of 2023, a soft landing seemed like a pipe dream, but it's more and more on the table as a possible outcome,” said Sean Snaith, the director of the University of Central Florida’s Institute for Economic Forecasting. “We’re probably facing more of a ‘near recession’ now than an actual one.”