Fed raises rates by 25bp as it chases lower core inflation

The Federal Open Market Committee unanimously voted to raise its target interest rate by 25 basis points today (May 3), to a range of 5% to 5.25%.

The FOMC said it would consider economic conditions “in determining the extent to which additional policy firming may be appropriate”.

The Federal Reserve removed a line from its statement, which had previously said policy-makers expect further rate hikes. Fed chair Jerome Powell called the removal of that expectation “a meaningful change”.

However, “inflation is running high, well above our goal,” Powell added. Headline personal consumption expenditures (PCE) inflation was 4.2% in March, down from 5.1% in February.

PCE inflation excluding food and energy was 4.6% in March, falling only slightly from February’s 4.7%. An alternative measure of core inflation, trimmed-mean PCE inflation, held steady at 4.7% in March.

Powell said he thought the economy was more likely to avoid a recession than not. But he didn’t rule out a recession, which he said he hopes would be mild.

Benjamin Friedman, professor of economics at Harvard University, tells Central Banking the Fed is right not to pause the tightening cycle this meeting.

“Pausing now would be a mistake,” Friedman says. “Inflation is too high, most sectors of the economy still look robust, and the three bank failures we’ve had have been idiosyncratic rather than a reflection of systemic problems with the banking system.”

Harald Uhlig, a professor of economics at the University of Chicago, agrees inflation is the priority and says a hard landing still seems unlikely. “It is the job of the Fed to take away the punch bowl, when the party gets going, and it should have done so much sooner,” says Uhlig. “The party still keeps going. This is not the time for the Fed to let up on its inflation vigilance.”

A question remains over whether rates will have to rise higher. Powell did not drop many hints in the press conference, saying “we’re going to need data to accumulate” before policy-makers can decide on a pause.

Paul Christopher, head of global market strategy at the Wells Fargo Investment Institute, says he believes rates will rise higher. “The Fed has told us that core services inflation is still too high, to the point that we believe they are likely to consider rate hikes after today. We also think inflation will remain sticky enough that rate cuts are unlikely in 2023.”

Christopher notes this view was not held by all equity investors, adding that this could trigger volatility in the months ahead.