After the Fed's first interest rate decision… The Fed increased interest rates and planned six more hikes by the end of the year. A quarter-point rate hike was expected and considered modest, but the Fed has also increased the number of rate hikes expected this year to help rein in its highest inflation in 40 years. So the Fed is signaling more rate hikes and warning that inflation will remain high for the rest of the year. In addition, the FOMC expects further tightening to an unemployment rate of 3.5%, which it expects to maintain through 2024.

 

Median wage increases, 3-month moving average… Source: Atlanta Fed

 

Criticism of inflation… The Fed faced criticism for underestimating inflation last year, and now more uncertainty lurks. Energy prices are soaring due to the war in Ukraine, and coronavirus fluctuations are shutting down China's major manufacturing centers. These phenomena exacerbate the global supply chain confusion that drives prices up.

 

Inflation still has a long way to go before it approaches normal levels, but the Fed should avoid interventions that are too drastic or abrupt that could cause a recession. According to the Fed's new projections, the Fed expects inflation to remain high, reaching 4.3% at the end of the year, taking into account rate hikes. Powell said he expects inflation to stay high until the middle of this year, then fall, and then fall more sharply next year. But that forecast depends on the invasion of Russia, the coronavirus quarantines in China, and how the US economy absorbs shocks from abroad.

 

March FOMC SEP inflation forecasts and comparison with previous forecasts. At Wednesday's meeting, the inflation forecast for the end of 2022 was 4.3%. Source: Federal Reserve, Summary of Economic Projections

 

The economic effects of raising interest rates… Raising interest rates has a cooling effect on the economy because it increases the costs associated with a wide range of loans, from mortgages and auto loans to commercial investments. There are criticisms that the Fed's rate hike against inflation is too late, and insufficient rates will lead to stagflation and recession. Of course, monetary policy does not aim to respond to short-term shocks in the economy, such as an energy shock. However, such shocks have the potential to put pressure on the economy, especially as they last longer, forcing the Fed to consider more aggressive moves in future rate hikes.

 

The central bank wants to achieve a soft landing in the economy. The situation in the yield curve has revealed recession fears because short-term rates are very close to long-term rates. In the normal yield curve, short-term interest rates are smaller than long-term interest rates, and the slope of the curve is upwards. Academic studies have often used the difference between the yield on a ten-year Treasury note, which reflects the long-term view of bond investors, and the three-month Treasury note yield, a close substitute for the targeted federal funds rate. On the other hand, commentators and policy makers also make heavy use of the difference between ten- and two-year returns. The trend in bond yields is influenced by monetary policy views. According to a study published in Chicago Fed; If long-term rates fall below short-term rates, it may also reflect the FOMC's expectation that aggressive monetary policy tightening, which will push current rates higher than future rates, will increase the likelihood of a future decline in economic activity. Thus, such movements in the yield curve will be associated with a higher probability of future recession.

 

Conclusion? The Fed relies on the tight labor market and believes the momentum brought by the economy from the pandemic is strong enough. This is the main reason Fed officials feel comfortable withdrawing economic support. But the Russian invasion will hold back economic growth and increase the risk of the US going into a recession. On the other hand, gas prices have soared to record highs, complicating the inflation side, amid fears that the war in Ukraine and sanctions against Russia will continue to strain global energy markets and push prices up. There is no data or indication that supply chain disruptions, which raise raw material and energy prices, will return to normal, and it seems that the 2% inflation target until 2024 will not be met by the Fed.

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