Fed to become even more aggressive in raising rates against inflation: Experts

By Ovunc Kutlu

ANKARA (AA) - The US Federal Reserve will signal that it is going to be even more aggressive in raising interest rates this year in order to tame record-high inflation, experts told Anadolu Agency on Wednesday.

After raising interest rates by 25 and 50 basis points in March and May, respectively, carrying the target range for the federal funds rate to 0.75%-1%, the Fed is widely expected to deliver a 50 basis point rate hike at the conclusion of its two-day meeting Wednesday.

Some Fed officials in recent weeks also signaled the possibility of a 75 basis point rate hike in September as consumer inflation hit 8.6% in May -- the highest annual gain since December 1981.

"I don’t expect a 75 bps increase in the funds rate, but I do expect 50 bps increases in June, July and September. I expect the funds rate will ultimately peak at 3.25% by early next year," Mark Zandi, chief economist at Moody's Analytics, said by email.

Ryan Sweet, an economist at Moody's Analytics, said the record consumer inflation in May "has rekindled talk of a 75-basis point rate hike" but added that the Fed will opt to stick with a 50 basis point hike and use its statement "to talk tough about inflation and strongly signal that the front-loading of rate hikes will continue."

"Another reason for the Fed not to hike by 75 basis points is that its strategy has been working as financial market conditions have tightened significantly. Monetary policy primarily affects the economy through financial market conditions. Therefore, the Fed will use other vehicles to strengthen its hawkish signal, including the post-meeting statement," he added.

- Markets in turmoil with recession fears

Due to the Fed's higher rate hike expectations, the US stock market last week recorded its worst weekly performance since January. On Monday, the Dow Jones Industrial Average fell 2.8% with a massive 876-point loss. The S&P 500 lost 3.9%, while the tech-heavy Nasdaq dove 4.7%.

The value of the cryptocurrency market, which has been highly correlated to the Nasdaq in recent months, plummeted below $1 trillion Monday – a level not seen in 17 months.

Many investors are worried that the Fed's hawkish stance and more aggressive rate hikes could trigger a recession in the US, despite Fed officials hoping for a soft landing – a process in which a central bank raises rates against high inflation and causes an economic slowdown but avoids a recession.

"While recession risks are uncomfortably high, the Fed should be able to thread the needle and raise rates high enough, fast enough to slow the economy’s growth and help quell inflation, but not too high, too fast to undermine the expansion," Zandi said.

"This does assume the (coronavirus) pandemic will continue to fade and global supply chains will continue to normalize and that the worst of the economic fallout from the Russian invasion, particularly on oil prices, is behind us," he added.

Zandi emphasized that fundamentals of the US economy such as household and corporate leverage, real estate markets and inventories are strong, and these should help the American economy navigate without suffering a recession.

But Sweet warned that the unemployment rate in the US could increase more than the Fed anticipates.

"A rising unemployment rate sends an ominous warning about a recession. There has never been an increase in the unemployment rate of more than 30 basis points, on a three-month moving average basis, that wasn’t associated with a recession. Therefore, once the labor market overshoots full employment, it will be extremely difficult for the Fed to pull off a soft landing," he said.

- Fed's 2% inflation target

While US inflation has climbed to its highest level in more than 40 years, the Fed forecasts it falling back to its 2% target not very soon.

The personal consumption expenditures (PCE) price index, the central bank's preferred inflation indicator, is expected to come in at 2.3% in 2024, according to its latest projections made in March.

The Fed will also release its new projections for economic growth, unemployment, the federal funds rate and PCE inflation Wednesday.

"The Fed’s new inflation forecast will be revised noticeably higher...the largest upward revisions will be to the headline PCE deflator, reflecting the sudden and significant increase in global energy prices. The median projection for the federal funds rate this year will likely be raised by 75 to 100 basis points, with a similar revision to the expected path of the Fed funds rate in 2023," Sweet said.

Zandi said a 2% inflation forecast for 2024 is realistic and stressed that the current high inflation is largely due to higher oil prices, which he said will stabilize and ultimately decline as global energy markets adjust to the loss of Russian oil supplies.

"I expect this to happen by 2024. I expect the Fed to signal that it will do whatever it takes to ensure that inflation moderates back to its target. This should help keep inflation expectations from rising and thus make it more likely they will succeed in reining in inflation," he added.