The Fed is hitting inflation with a heavy hand, as it announced an interest rate hike of 50 basis points, or 0.5%, at the conclusion of its two-day May meeting on Wednesday afternoon. The Fed is also shrinking its $9 trillion balance sheet, effectively withdrawing pandemic-related monetary economic support, all in an effort to blunt rising prices.
“Inflation is much too high,” said Fed Chairman Jerome Powell at a press conference following the Fed’s meeting. He noted that the Fed is, in response, “moving expeditiously to bring it down.” He also said that the Fed anticipates that further rate hikes “will be appropriate.”
Theoretically, by increasing interest rates, the Fed makes it more expensive to borrow money. When borrowing costs go up, consumers should be less likely to make big purchases (homes, cars, etc.), squashing demand, increasing supply, and lowering prices. The rate hike was not unexpected, either, as inflation rates have hit levels not seen in decades in recent months. It first lifted interest rates in March—the first increase since 2018—and it’s expected to keep raising rates in the months to come.
“I think we’re in for a tightening cycle unlike we’ve seen in a very long time,” says Danielle Hale, chief economist at Realtor.com. “Given where price trends are, the Fed does need to act pretty decisively.”
The Fed has two main goals: keeping unemployment low and prices stable. While the unemployment rate is sitting pretty at 3.6%, the Fed has lost its handle on prices. The Consumer Price Index (CPI) was up 8.5% year-over-year in March, whereas the Fed aims for an annual increase of 2%. And though rate hikes are likely to cool down some sectors of the economy, housing isn’t one of them.
Housing is one sector of the economy in which prices have risen substantially over the last couple of years, with home prices increasing nearly 20% between February 2021 and February 2022. But even a significant rate hike won’t be enough to suffocate demand, as a shortage of supply remains the main driver of price increases.
With that in mind, here are three key takeaways from the Fed’s meeting:
1. The 50 basis-point hike was expected
While the latest interest rate hike is hefty (the largest since 2000), it’s not catching anyone off guard. The markets already priced the increase in, says Hale, as evidenced by the lackluster performance of stocks in recent weeks. Even so, it’ll take some time before many consumers feel the effects of higher rates, as there’s generally a lag between the Fed’s adjustments and when those changes are felt by consumers.
2. Another—or bigger—increase in June?
While Powell says that “there is a broad consensus among the committee that additional 50-basis point increases should be on the table” at further meetings, it’s possible that the Fed will up the ante. Hale says a 75-basis point increase in June may be more in line with expectations. “The Fed will continue to raise rates, and right now, the market is expecting a 75 basis-point hike in June,” she says. “That would be the largest since the mid-1990s.”
3. Recession watch
Following some disappointing GDP numbers released last week, which showed that the economy contracted 1.4% during the first quarter of 2022, fears are mounting about the possibility of a recession. The Fed is walking something of a tightrope, by simultaneously trying to slow the economy down without raising unemployment.
The good news, despite the ugly GDP numbers last quarter, is that it seems consumers and businesses are still chugging along. “GDP contraction was largely due to businesses spending less on inventory, and not consumers or businesses pulling back,” Hale says.
That said, the prospect of a recession—which is, technically, two straight quarters of economic contraction—is on the collective radar. That doesn’t mean it’s imminent, but it’s something to keep an eye on as rates continue to rise, and the economy slows down. But the risk of triggering a recession is one the Fed now needs to take to calm price increases.