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The Effect of Fed Interest Rate Hikes

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The FED is expected to raise the interest rates by a quarter-point. This comes as a major move to reverse the extraordinary easing it had put in place two years ago just to help the economy stay stable during the pandemic years.

It is also expected that this year, we might be seeing as many as five or six more quarter-point hikes and a possible three or four more in 2023. These moves are meant to combat high inflation.

But how easy will this be? Not easy at all!  Economists now say that raising the interest rates poses unique risks to the economic growth that the Fed may not be able to raise the interest rates as much as it would like to. The current conflict between Ukraine and Russia has made inflation in the country much worse creating more risks for economic growth. Furthermore, while Covid-19 may have been combated and kept at bay in most parts of the country, it becomes a problem in China where there are lockdowns and this could upset the supply chain balance causing disruptions.

 “There’s a dark cloud of uncertainty over this meeting, but at the end of the day, they know they’re at zero,” said Jim Caron, a chief fixed-income strategist on the global fixed-income team at Morgan Stanley Investment Management.

“The economy is coming into full employment rapidly and inflation is way too high,” he said. “You add that all up and that means they’ve got to raise rates. The degree of uncertainty is extraordinary. They told us what they were going to do. They did that to get rid of the uncertainty.”

When the pandemic first broke out in the country, the Federal Reserve took steps to protect the economy and one of them was taking its funds target rate range to zero to 0.25% in early 2020. In addition, it took steps to add more liquidity including quantitative easing programs to buy the Treasurys and Mortgage bonds that it is just winding down this month.

But with inflation now almost at 8%, some economists say that the FED is late and well behind the curve in its fight against the rapidly rising prices.

“I think the world really changed with this war, and [it] would have been inflation that would have come down by the middle of this year. It would have come down to more normalized levels,” said Rick Rieder, a chief investment officer of global fixed income at BlackRock. “The impact on energy, commodities, food is real. I just think it really changed the inflationary paradigm to be significantly worse.”

“This complicates things that they’re starting at zero. I suspect financial conditions are going to tighten significantly and do some of the work for the Fed,” said Mark Zandi, chief economist at Moody’s Analytics. “The Fed is desperately trying to balance things and avoid going into recession. It really does depend on what happens with the stock market, credit spreads, sentiment … and whatever other geopolitical problems come down the road.”

While Zandi is not expecting a recession, the odds of it happening have risen 1 in 3 in the next 18 months.

“The Fed’s immediate reaction is going to be to fight inflation, but down the road, it has to look at slower growth from higher oil prices,” said Zandi. “That’s an important unique aspect of this, but at the same time we have to put this in context; the Fed is already late to the game.”





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