The Fed raised key interest rate by 75 basis points and signaled that a similar move could be expected in July. The announced pace of tightening means that the federal funds rate is likely to be above 3% by the end of the year, therefore the dollar will likely offer one of the best real yield prospects among G10 peers in the second half of the year. However, a decisive fight against inflation will have its costs, namely, mounting risks of a “hard landing” of the US economy, in which case the Fed may need to ease policy as quickly as it tightened it.After the first in 22 years rate hike by 50 bp in May, the Fed accelerated the pace of tightening and moved to a 75bp hike, confirming the trend of major central banks to step up the pace of policy normalization. Markets were preparing for such an outcome in advance, in particular, these expectations were based on US inflation data for May, which showed that inflation peak had not been passed, as well as household inflation expectations from U. of Michigan, which jumped in the previous month, threatening to deanchor from the Fed target. This, in turn, was fraught with a loss of credibility in the Fed, which is a major cost of conducting monetary policy, so yesterday the Fed showed determination and hinted that even 75 bp rate hike is not the limit.New Fed forecasts indicate that the pace of policy tightening will remain high for at least the next few months or even until the end of the year. The median interest rate forecast for the end of this year has changed from 1.9% to 3.4%, from 2.8% to 3.8% for the end of 2023, from 2.8% to 3.4% for the end of 2024 and from 2.4% to 2.5% for the long term. Even traditional FOMC doves expect federal funds rate to climb above 3% by the end of the year:In the accompanying statement, the Fed excluded the wording that the Central Bank “expects inflation to gradually decline to the target level”, instead using “committed to fighting inflation and is “highly attentive” to risks in this area.Such an aggressive stance in monetary policy was not without an increase in expected costs, which the Central Bank acknowledged in its GDP and inflation forecasts. According to the fresh economic staff projections, the Fed lowered its expected GDP growth rate in Q4 2022 from 2.8% to 1.7% and from 2.2% to 1.7% for Q4 2023:The risks to the Fed projections on the path of the interest rate are clearly on the upside. The natural movement of inflation towards the target level at the pace desired by the Fed implies that supply should adjust to strong demand. However, restrictions due to covid in Asia and a shortage of labor in the US suggest that this will not happen quickly. Therefore, inflation can remain sustainably at elevated levels, forcing the Fed to destroy consumer demand with monetary tightening in order to bring inflation back under control.
Source: Tickmill
