In an announcement on Wednesday, the Federal Reserve confirmed that it will hold the line on interest rates, while its updated economic forecasts indicate a likely rise of half a percentage point by year-end. This adjustment comes in response to the U.S. economy's unexpected robustness and a slower than projected drop in inflation.
The Federal Open Market Committee (FOMC), which determines interest rates, unanimously agreed to keep the target range as it is for now, allowing the committee time to consider new information and its implications for fiscal policy. This approach is part of an effort to balance potential economic risks with the ongoing challenge of curbing inflation.
In a statement, the FOMC suggested that future rate increases would consider factors such as the cumulative impact of monetary tightening, the delays with which fiscal policy influences economic activity and inflation, and general economic and financial developments.
The newly released projections indicate a hawkish tilt to the interest rate decision made on Wednesday. By year-end, policymakers predict the benchmark overnight interest rate will increase from the current range of 5.00%-5.25% to a range of 5.50%-5.75%. Among the 18 Fed officials, half expect the policy rate to be at that level, while three forecast an even higher rate, including one predicting it to exceed 6%.
Only two Fed officials anticipate rates will remain steady, while four envision a single quarter-percentage-point increase as probable.
However, policymakers are predicting a total of 100 basis points worth of rate reductions in 2024, alongside a rapid decline in inflation.
Taken together, the projections and rate outlook are likely to steer investors towards expecting quarter-percentage-point rate increases to recommence at the policy meeting in July.
Following the decision, U.S. stocks took a hit, and traders of policy rate futures are now pricing in about a 75% chance of another rate hike in July, with the odds of a rate cut by year-end falling.
Sam Stovall, Chief Investment Strategist at SFRA Research, suggested that the shift towards a more hawkish stance by the FOMC members since the last meeting caught investors off guard.
The upgraded rate outlook coincides with a more optimistic view of the economy and a consequent slower reduction in inflation to reach the central bank's 2% target.
Compared to the March projections, Fed officials have significantly boosted their 2023 economic growth outlook, from 0.4% to 1%, and now anticipate the unemployment rate to rise only to 4.1% by year-end, compared to a previous prediction of 4.5%. As of May, the jobless rate stood at 3.7%.
The healthier-than-anticipated economy indicates a slower pace of inflation decline, with the core Personal Consumption Expenditures Price Index expected to drop from the current 4.7% to 3.9% by the end of 2023. This compares with a predicted 3.6% year-end rate from the March forecasts.
The decision ends a series of 10 consecutive rate increases by the Fed, initiated in response to the worst inflation surge in 40 years, which led to a series of aggressive policy moves, including four three-quarter of a percentage point increases last year.
With the onset of tightening policies in March 2022, the central bank's policy rate, a significant influencer of borrowing costs across the economy, rose by 5 percentage points, reaching its highest level since the start of the 2007-2009 recession.
