The Dow Jones swung wildly after the announcement but closed up 1 per cent while the Nasdaq added 2.5 per cent. The Australian sharemarket is set to open higher,with futures at 6.04am AEST pointing to a gain of 20 points,or 0.3 per cent,at the open. TheASX dropped by 1.3 per cent on Wednesday.
Inflation has shot to the top of voter concerns in the months before Congress’ midterm elections,souring the public’s view of the economy,weakening President Joe Biden’s approval ratings and raising the likelihood of Democratic losses in November. Biden has sought to show he recognises the pain that inflation is causing American households but has struggled to find policy actions that might make a real difference. The president has stressed his belief that the power to curb inflation rests mainly with the Fed.
A worrying US inflation report last week triggered the aggressive hike.Credit:Bloomberg
Yet the Fed’s rate hikes are blunt tools for trying to lower inflation while also sustaining growth. Shortages of oil,petrol and food are escalating prices. The Fed isn’t ideally suited to address many of the roots of inflation,which involve Russia’s invasion of Ukraine,still-clogged global supply chains,labor shortages and surging demand for services from airline tickets to restaurant meals.
At his news conference,Powell struck a defensive note when asked whether the Fed was now prepared to accept a recession as the price of curbing inflation and bringing it close to the Fed 2 per cent target level.
“We’re not trying to induce a recession now,” he said. “Let’s be clear about that. We’re trying to achieve 2 per cent inflation.”
Borrowing costs have already risen sharply across much of the U.S. economy in response to the Fed’s moves,with the average 30-year fixed mortgage rate topping 6 per cent,its highest level since before the 2008 financial crisis,up from just 3 per cent at the start of the year. The yield on the 2-year Treasury note,a benchmark for corporate borrowing,has jumped to 3.3 per cent,its highest level since 2007.
Even if a recession can be avoided,economists say it’s almost inevitable that the Fed will have to inflict some pain — most likely in the form of higher unemployment — as the price of defeating chronically high inflation.
“We’re not trying to induce a recession now. Let’s be clear about that. We’re trying to achieve 2 per cent inflation.”
Fed chair Jerome Powell
In their updated forecasts Wednesday,the Fed’s policymakers indicated that after this year’s rate increases,they foresee two more rate hikes by the end of 2023,at which point they expect inflation to finally fall below 3 per cent,close to their target level. But they expect inflation to still be 5.2 per cent at the end of this year,much higher than they’d estimated in March.
Over the next two years,the officials are forecasting a much weaker economy than was envisioned in March. They expect the unemployment rate to reach 3.7 per cent by year’s end and 3.9 per cent by the end of 2023. Those are only slight increases from the current 3.6 per cent jobless rate. But they mark the first time since it began raising rates that the Fed has acknowledged that its actions will weaken the economy.
The central bank has also sharply lowered its projections for economic growth,to 1.7 per cent this year and next. That’s below its outlook in March but better than some economists’ expectation for a recession next year.
Expectations for larger Fed hikes have sent a range of interest rates to their highest points in years. The yield on the 2-year Treasury,a benchmark for corporate bonds,has reached 3.3 per cent,its highest level since 2007. The 10-year Treasury yield,which directly affects mortgage rates,has hit 3.4 per cent,the highest level since 2011.
Wall Street moved wildly after the rates announcement,but the Fed’s assurances that big rises would not be common seemed to soothe markets.Credit:AP
Investments around the world,from bonds to bitcoin,have tumbled on fears surrounding inflation and the prospect that the Fed’s aggressive drive to control it will cause a recession. Even if the Fed manages the delicate trick of curbing inflation without causing a downturn,higher rates will nevertheless inflict pressure on stocks. The S&P 500 has already sunk more than 20 per cent this year,meeting the definition of a bear market.
Other central banks are also acting swiftly to try to quell inflation,even with their nations at greater risk of recession than the US. The European Central Bank is expected to raise rates by a quarter-point in July,its first increase in 11 years. It could announce a larger hike in September if record-high levels of inflation persist. On Wednesday,the ECB vowed to create a market backstop that could buffer member countries against financial turmoil of the kind that erupted during a debt crisis more than a decade ago.
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The Bank of England has raised rates four times since December to a 13-year high,despite predictions that economic growth will be unchanged in the second quarter. The BOE will hold an interest rate meeting on Thursday.
Last week,the World Bank warned of the threat of “stagflation” — slow growth accompanied by high inflation — around the world.
AP