Investors Now Expect Fed to Raise Rates Faster Than It Has in a Generation

Investors expect the Federal Reserve to move much more aggressively with hiking interest rates in the coming months as inflation rises to multidecade highs

Federal Reserve Chairman Jerome Powell signaled on Monday that he was open to hiking rates by a half percentage point at upcoming Fed meetings, a departure from the traditional quarter-percentage-point increases. Markets are now pricing in the Fed taking the more extreme tack, which hasn’t been done in more than two decades.

Goldman Sachs now forecasts that the central bank will raise rates by 50 basis points, effectively conducting two hikes in one, during its next two Federal Open Market Committee meetings in May and June. If the Fed decides to do so, it would be the first time since the mid-1990s that back-to-back half-point hikes were done. 

“The labor market is very strong, and inflation is much too high,” Powell said during a Monday economics conference. “There is an obvious need to move expeditiously to return the stance of monetary policy to a more neutral level, and then to move to more restrictive levels if that is what is required to restore price stability.”

“If we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so,” he added. 

Powell’s remarks come less than a week after the Fed announced it would raise its interest rate target by a quarter of a percentage point, the first rate hike since 2018. The central bank had declined the more forceful increase in light of the uncertainty surrounding the war in Ukraine and the pandemic. 

Inflation is running hot, with consumer prices increasing by 7.9% for the 12 months ending in February. Some have been calling for tighter monetary policy for months, and now, markets seem to think the Fed will act at its next meetings. 

“Our best guess is that the shift in wording from ‘steadily’ in January to ‘expeditiously’ today is a signal that a 50bp rate hike is coming,” Goldman Sachs analysts wrote in a report after Powell’s comments on Monday. 

Most investors now foresee a half-point hike in May, with the likelihood of the more aggressive rate hike occurring pegged at more than 65%, according to CME Group’s FedWatch tool, which calculates the probability using Fed fund futures contract prices. 

Not every participant in last week’s FOMC meeting wanted to see just a quarter-point hike. St. Louis Federal ReservePresident James Bullard, who has been calling for tighter monetary policy for some time, dissented and said the target should have been increased to 50 basis points. 

He pointed to the strength of the U.S. economy as proof it could handle the more aggressive action. Fed officials forecast 2.8% gross domestic product, adjusted for inflation, in 2022, less than projected in December but still in line with the years preceding the pandemic. 

The economy also once again exceeded expectations and notched 678,000 more jobs in February, a promising sign that the labor market is returning to its pre-pandemic strength. The unemployment rate is at 3.8%, the lowest level since the health crisis began. 

The only major economic malady that the Fed is staring down right now is inflation. 

“The combination of strong real economic performance and unexpectedly high inflation means that the Committee’s policy rate is currently far too low to prudently manage the U.S. macroeconomic situation,” Bullard said last week.

“Moreover, U.S. monetary policy has been unwittingly easing further because inflation has risen sharply while the policy rate has remained very low, pushing short-term real interest rates lower,” he added. 

Fed officials indicated after last week’s meeting that they expect between six and eight rate hikes over the course of this year, although that number could increase or decrease depending on the changing economic landscape.

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