Fed Rate Hikes: Sledgehammer or Scalpel?
By the end of 2022, the Federal Reserve had raised interest rates seven times in an effort to maintain the annual inflation rate at 9.0%. The Fed's rate increases, though efficient, may end up being too forceful compared to a more targeted approach in moderating the economy and controlling inflation. If the Federal Reserve increases interest rates too slowly, inflation may persist; too quickly, however, and there is a risk that the Fed will cause a recession, resulting in millions of people losing their jobs.
The Federal Reserve has already seen a decrease in inflation from its high of 9.1% in the past year, thanks to a series of increases in interest rates. The inflation rate of 6.5% is significantly higher than the Federal Reserve's target of 2%–3%, which means that more interest rate hikes are likely to occur during the first half of 2021. There is a disagreement among economists regarding whether the Federal Reserve has raised interest rates too quickly and too much.
For months, the Federal Reserve has been cautioning markets that controlling inflation will take time and requires higher interest rates, due to a strong labor market, optimistic shoppers and a surprisingly strong economy. The Federal Reserve's interest rate hikes could lead to a recession and put millions of people out of work, and economists are concerned because inflation in January was smaller than expected.
In January, short-term interest rates rose in anticipation of further Fed tightening. The 3-month Treasury note's yield went from 4.42% at the end of December to 4.70% at the end of January, which is similar to the 25-basis point (bps) increment of the federal funds rate on February 1. It is to be expected that short-term rates are connected to the Federal Reserve's policy and the federal funds rate. Longer-term interest rates usually take into account anticipated inflation and potential Federal Reserve actions in the future. Throughout the month, long-term rates decreased in contrast to short-term rates. At the end of December, the yield on 10-year Treasury notes was 3.88%. By the end of January, however, it had fallen to 3.52%, reflecting both lower inflation expectations and diminished expectations for the Federal Reserve to continue tightening. Moreover, the likelihood of Fed easing in the coming year has increased in the market.
0. “Question of the month: How do you maneuver uncertainty in today's economy? – by Alan Doyle” New England Real Estate Journal Online, 10 Feb. 2023, https://nerej.com/question-of-the-month-how-do-you-maneuver-uncertainty-in-today-s-economy-by-alan-doyle
1. “DAVID BERSON: Equity and fixed-income markets responding favorably” Sarasota Herald-Tribune, 13 Feb. 2023, https://www.heraldtribune.com/story/business/2023/02/13/david-berson-equity-and-fixed-income-markets-responding-favorably/69876398007/
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