Why suspend interest rate hikes?, Federal Reserve

Hot Q&A | Why the Federal Reserve Suspends Interest Rate hikes

The Federal Reserve announced a pause in interest rate hikes after its monetary policy meeting ended on the 14th, marking the first time the Federal Reserve has pressed the pause button after 10 consecutive rate hikes in over a year, marking a new phase of the rate hike cycle that began in March 2022.

Why is the Federal Reserve suspending interest rate hikes at this time in the face of still high inflation? When will the interest rate hike be restarted? Why is the Federal Reserve in a dilemma of both fighting inflation and preventing financial risks?

Why suspend interest rate hikes

On June 14th, Federal Reserve Chairman Powell attended a press conference in Washington. The Federal Reserve Board of the United States concluded its two-day monetary policy meeting on the 14th and announced that the target range for the federal funds rate, which ranges from 5% to 5.25%, will remain unchanged.

Since the start of this interest rate hike cycle in March 2022, the Federal Reserve has raised interest rates 10 times in a row, with a cumulative increase of 500 basis points, which is the fastest pace of interest rate hikes since the 1980s. Since the beginning of this year, the Federal Reserve has slowed down its pace of interest rate hikes, raising rates by 25 basis points in the past three meetings. After the May monetary policy meeting, the target range for the federal funds rate reached 5% to 5.25%.

Federal Reserve Chairman Powell told the media after a two-day interest rate meeting that the full impact of tightening policies has not yet been apparent, and the Federal Reserve is much closer to its goal of reducing inflation. Slowing down the pace of interest rate hikes is reasonable. The Federal Open Market Committee, the decision-making body of the Federal Reserve, issued a statement after the meeting stating that suspending interest rate hikes allows the committee to evaluate more information and its impact on monetary policy. The committee will consider the cumulative tightening of monetary policy, the degree to which monetary policy lags behind economic activity and inflation, as well as economic and financial trends.

Economist Desmond Rahman from the American Enterprise Research Institute told Xinhua News Agency that there are signs that the US economy is cooling down and the financial system is facing enormous pressure after a significant interest rate hike. The Federal Reserve's suspension of interest rate hikes is "reasonable".

The Federal Reserve has been soaring on the path of interest rate hikes, pushing interest rates to the highest level in 16 years, and its inhibitory effect on economic growth has become more apparent. The report from the World Federation of Large Enterprises shows that the consumer confidence index declined in May, leading to a "serious deterioration" in consumer evaluations of the current employment situation.

The aggressive interest rate hike by the Federal Reserve also brought shock to the banking industry, triggering the closure of Silicon Valley Bank and Signature Bank in March, and the closure of First Republic Bank in early May. Dean Mekey, Chief Economist at hedge fund Point72 Asset Management, believes that the bank closures have made the Federal Reserve's rate hikes less aggressive than before.

When to restart interest rate hikes

This is the Federal Reserve Building captured on June 22, 2022 in Washington, D.C., USA.

The suspension of interest rate hikes by the Federal Reserve does not mean the end of this round of rate hikes. Powell stated at a press conference on the 14th that almost all members of the Open Market Committee believe that further interest rate hikes within this year are appropriate.

According to the latest quarterly economic forecast released by the Federal Reserve on the 14th, Federal Reserve officials have predicted a median federal funds rate of 5.6% for the end of this year, significantly higher than the March forecast of 5.1%. The bar chart shows that among 18 Federal Reserve officials, 12 believe that interest rates should be raised to at least 5.5% to 5.75% by the end of this year, and 3 of them believe that interest rates should be higher. This means that the Federal Reserve still has 50 basis points of room for interest rate hikes this year.

Bank of America Chief US Economist Michael Garpen said it is surprising that Federal Reserve officials have predicted a 50 basis point increase in the federal funds rate for this year compared to their March forecast. He expects the Federal Reserve to raise interest rates by 25 basis points in July and September, respectively. There are also predictions that the Federal Reserve will raise interest rates by another 25 basis points this year.

The Federal Reserve has not yet made a decision on whether to raise interest rates at the July monetary policy meeting, but the Chicago Mercantile Exchange's Federal Reserve observation tool shows that as of the evening of the 14th local time, traders expect the probability of the Federal Reserve raising interest rates by 25 basis points in July to exceed 70%.

Powell stated that achieving the inflation target is likely to require the economy to bear some pain, and the "boots" of economic recession cannot be left behind, making it difficult for monetary policy to turn and a new economic cycle to start. He also stated that it would be appropriate for the Federal Reserve to lower interest rates only after inflation has significantly decreased, and no committee member expects a rate cut this year.

Why is the Federal Reserve in a dilemma

On March 13th, customers queued up outside the headquarters of Silicon Valley Bank in Santa Clara, California, USA to process their business.

In the dual dilemma of inflation still significantly above the target and the banking crisis not yet fully resolved, there are disagreements among Federal Reserve officials and market observers on whether to continue raising interest rates, and the road ahead is bound to be difficult. Analysts believe that the reason why the Federal Reserve is in the current predicament is due to an early misjudgment of the situation, which led to the United States experiencing the most severe inflation in 40 years, and then having to aggressively raise interest rates, posing risks to financial stability and economic development.

Rahman told reporters that the Federal Reserve made a mistake in 2021 by keeping interest rates too low for a long time in the context of massive fiscal stimulus measures, ultimately leading to the highest inflation in decades. Rahman said that if the Federal Reserve continues to raise interest rates, it may lead to an economic recession, and it should not adopt "excessive monetary policy" to regain control of inflation.

US Treasury Secretary Yellen stated in March that the continued interest rate hikes by the Federal Reserve were the main cause of consecutive bank closures. The Federal Reserve and the Federal Reserve Insurance Company have also released investigation reports on bank closures, reflecting on underlying reasons such as monetary policy deficiencies and regulatory deficiencies. Yellen recently stated in an interview with US media that, considering the overall environment of the banking industry, some smaller banks may still face consolidation.

Despite the slowdown in economic growth and pressure on the banking industry caused by high interest rates, the Federal Reserve still hinted at the next step of interest rate hikes, fundamentally due to current inflation levels still significantly exceeding its long-term target of 2%.

According to data recently released by the US Department of Labor, after excluding volatile food and energy prices, the core consumer price index still saw a year-on-year increase of 5.3% in May.

Analysts believe that in addition to the implementation of ultra loose monetary policy and fiscal policy during the COVID-19 epidemic, the trend of deglobalization, supply chain disruption and the reduction of labor supply caused by the epidemic also contribute to the current round of inflation in the United States, so it will take longer to resolve the inflation dilemma.