The rate hike everyone expected is finally here
The Federal Reserve raised interest rates Wednesday for the first time in more than three years, reversing part of the easing that had taken place since the end of the previous hiking cycle.
The 25-basis-point increase brings the federal funds target range to 3.75% to 4.00%. The decision was unanimous and came after stronger employment data, stubborn inflation and rising energy costs pushed expectations for a hike close to 90% before the meeting.
The Fed did not describe an economy in need of rescue. Officials said economic activity remains solid, domestic spending has been resilient, productivity growth is strong and capital investment remains robust. Employment has also kept pace with growth in the workforce.
That helps explain why policymakers are comfortable tightening again. Inflation remains the problem, while the economy has so far been strong enough to absorb higher rates.
One more hike is now the Fed’s base case
The new dot plot shows the median Fed official expecting one additional rate increase before the end of 2026.
That is considerably more important than Wednesday’s decision itself. A quarter-point hike was already reflected in markets; the uncertainty now surrounds how persistent the inflation problem becomes and how aggressively the Fed responds.
Bank of America is more hawkish than the Fed’s median projection. Its economists expect another 25-basis-point increase in October followed by a third in December, effectively reversing the insurance cuts delivered last year.
Markets are not fully buying that scenario yet. Futures pricing suggests two total hikes this year remain more likely than three.
This does not look like 2022 yet
There is an important difference between restarting rate hikes and entering another aggressive tightening campaign.
The Fed is not responding to runaway inflation with emergency-sized increases. It is making smaller adjustments while the economy remains relatively strong, giving policymakers room to watch the data before committing to the next move.
Energy prices could complicate that approach. Oil above $100 and elevated fuel costs are feeding back into inflation just as the Fed had hoped price pressures were moving closer to target. If that persists, the case for additional hikes strengthens.
A softer inflation reading or cooling economy could just as easily slow the process.
That makes the next few months much more data-dependent than the decision investors received Wednesday.
The next hike matters more than this one
The first increase was expected. The second will tell us much more.
If the Fed raises rates once more and then pauses, markets may view this as a limited correction to inflation that proved more persistent than expected. A third hike would begin to look more like the start of a genuine tightening cycle, with greater consequences for bond yields, borrowing costs and equity valuations.
Chair Kevin Warsh’s messaging and the next round of inflation and employment data will shape that debate.
The Fed has started moving rates higher again. The question is whether it only needs a small adjustment, or whether inflation is forcing monetary policy into a much longer fight.
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