Interest rate hike over the past 12 months, has taken interest rates to 4.5 percentage points, marking the most rapid adjustment in interest rates since the 1980s. It is widely anticipated that the FED will enact another quarter-percentage-point increase to the interest rates in March.
The Fed officials have projected that the unemployment rate would rise to about 4.6% by the end of this year. The move to increase interest rates is aimed at lowering inflation by restraining growth in the economy. On Wednesday, Fed officials are likely to raise their benchmark federal-funds rate by a quarter percentage point to a range between 4.5% and 4.75%.
The increase in interest rates has raised concerns among investors who think that the lags are long. They anticipate that the Fed will cut rates later this year and through 2024 because they believe that the current interest rates are likely to cause a recession. However, projections released after the December policy meeting indicated that most Fed officials thought they would raise the fed-funds rate to 5.1% this year, implying quarter-point rate increases at their next two meetings in March and May. More than a third of officials anticipated lifting the rate above 5.25%, calling for another increase in June. No officials projected cuts this year.
Fed funds futures currently see a 25% chance of a 50 bps rate hike in March 2023, down from a high of 36% after PCE inflation last week. However, investors still see a 41% chance of rates rising to 5.75% or higher. Notably, zero rate cuts are expected in 2023. The rising interest rate expectations are back on the table, with the market seeing a 26% chance of a 50 bps rate hike in March 2023. Additionally, there is a 28% chance that rates will rise as high as 5.75% by July.
In the event that higher interest rates cause another financial crisis, but inflation remains well above the 2% target, it is unclear what the Fed will do. Markets have fallen as the Fed shows no sign of pausing interest rate hikes. Based on current levels of inflation and unemployment, the Taylor Rule suggests that the Fed’s benchmark interest rate could hit 9%.
During the last meeting of the Fed, officials signaled that a resilient U.S. economy could lead them to raise interest rates somewhat higher than they had anticipated to conquer high inflation. However, the process of lowering inflation to the Fed’s goal of 2% “is likely to take quite a bit of time. It’s not going to be, we don’t think, smooth,” Mr. Powell said. “It’s probably going to be bumpy.”
The Fed’s Monetary Policy Campaign
The Fed’s monetary policy campaign is the most aggressive in decades. It involves a series of interest rate hikes and tightening of the Fed’s balance sheet. The Fed is widely expected to raise interest rates by another quarter of a percentage point in mid-March, and many economists envision a further increase to between 5.2% and 5.5% in the near future.
Potential Outcomes of Interest Rate Hikes
If the Fed raises its benchmark rate to between 5.2% and 5.5%, which many economists foresee, it could result in the unemployment rate rising to 5.1% and inflation falling as low as 2.9% by the end of 2025.
Implications of Increasing Interest Rates
The increase in interest rates has several implications for the US economy. Firstly, it makes borrowing more expensive for businesses and individuals, leading to a decline in spending and investment. This could lead to a slowdown in economic growth, which could eventually lead to a recession. Additionally, the increase in interest rates has a ripple effect on other economic factors such as housing prices, the stock market, and the value of the dollar.
Housing prices could decline as the cost of borrowing increases, making it harder for people to purchase homes. Furthermore, the stock market could experience a decline as higher interest rates increase the cost of borrowing for companies, resulting in lower profits. The value of the dollar could also increase as higher interest rates attract foreign investors, leading to a decline in exports and an increase in imports.
Moreover, the increase in interest rates could impact inflation in the long term.
In light of these factors, it’s important to analyze the current state of interest rate hikes and their potential impact on the economy and financial markets.
The Fed’s Interest Rate Hikes: A Balancing Act
The Federal Reserve’s interest rate hikes are a delicate balancing act aimed at addressing two main concerns: rising inflation and a potentially overheated economy. On the one hand, higher interest rates can help to reduce inflationary pressures by slowing economic growth and making it more expensive for businesses and consumers to borrow money. On the other hand, if interest rates rise too quickly or too high, it could lead to a slowdown in economic activity or even a recession.
Over the past 12 months, the Fed has raised rates by 4.5 percentage points, the fastest pace since the 1980s. They are projected to continue this trend by raising their benchmark federal-funds rate by a quarter percentage point to a range between 4.5% and 4.75% at their next meeting. The goal of these hikes is to keep inflation under control by restraining growth.
The Market’s Reaction to Interest Rate Hikes
Investors have mixed opinions on the effects of interest rate hikes on the economy and financial markets. Many believe that the current rate hikes are too aggressive and could lead to a recession, while others argue that they are necessary to curb inflationary pressures.
Despite concerns about the negative impact of rate hikes, the markets have shown some resilience. However, there have been instances where the markets have fallen as a result of the Fed’s decisions. For instance, in December 2021, the markets fell as the Fed showed no sign of pausing interest rate hikes.
Future Interest Rate Expectations
Investors are currently anticipating further interest rate hikes in the future, with some predicting rates to rise as high as 5.75% by July. However, the Fed’s projection released after their policy meeting in December suggests that they plan to raise the fed-funds rate to 5.1% this year, with quarter-point rate increases expected at their next two meetings, in March and May. More than a third of officials anticipate lifting the rate above 5.25%, which would call for another increase in June. No officials project cuts this year.
Despite these projections, some investors believe that the Fed will eventually cut rates later this year and through 2024, as they think the Fed has already lifted them to levels likely to cause a recession. Fed funds futures are currently pricing in a 25% chance of a 50 bps rate hike in March 2023, down from a high of 36% after PCE inflation last week. However, there is still a 41% chance of rates rising to 5.75%+.
Potential Risks and Uncertainties
As the Fed continues to balance the need to control inflation and promote economic growth, there are several potential risks and uncertainties to consider. One concern is that higher interest rates could cause another financial crisis, while inflation remains well above the 2% target. The market is also concerned about the potential impact of interest rate hikes on the housing market, which could lead to a slowdown in the real estate sector.
Another factor to consider is the potential impact of interest rate hikes on global markets. Higher U.S. interest rates could lead to a stronger dollar, making exports more expensive and potentially hurting emerging markets that rely on exports for growth.
The M2 money supply has just experienced its largest year-over-year decline on record, indicating that the Federal Reserve’s (Fed) monetary policy campaign may be showing results. However, the big question is whether the Fed can achieve its target inflation rate of 2% in a reasonable period. In this article, we will take a closer look at the recent decline in M2, its significance, and what it means for the economy.
What is M2 Money Supply?
M2 is a measure of the aggregate currency and coins held by banks, travelers’ checks, balances in retail money-market funds, savings deposits, and more. The Fed started publishing M2 data in 1959, and it is used to gauge the amount of liquidity in the system.
Recent Decline in M2
Data for January showed a negative growth rate of 1.7% versus a year ago, the biggest year-over-year decline on record, and the first time it has contracted in back-to-back months. December’s money supply growth rate was a negative 1.12% versus the previous year, the first-ever decline. The monthly growth rate has been falling consistently since mid-2021, following a historic peak of 27% growth in February 2021.