The question is, when will the pace and size of the Fed’s interest rate moves start to moderate in an attempt at a soft landing?
With elevated prices now posing a real threat to demand and to the economy, the Fed was forced to act. It started by ending its quantitative easing programs, stopping the buying of bonds and ETFs. It also began to ratchet up interest rates. Starting in March, Fed officials raised benchmark rates by 0.25%. This was followed by a 0.5% raise in May and a 0.75% increase in June.
Then in July, the Fed enacted additional measures to stop inflation. This time it was another 0.75% increase to the benchmark rate to the range of 2.25%-2.5%. This pace of rate hikes hasn’t been seen since former Fed Chair Paul Volcker’s attempt to cool inflation during the 1980s.
These results were in-line with a survey conducted by Mitre Media, publisher of MutualFunds.com, MunicipalBonds.com, and Dividend.com. Out of nearly 500 valid responses from advisors, institutional investors and individual investors, about half of those surveyed (54% of advisors, 45% of individual investors) estimated that the Fed would raise by 0.75%. Nearly 45% of the surveyed advisors managed assets of at least $25 million, highlighting a credible viewpoint echoed by investors across the board.
With the 0.75% July hike now set in stone, the question is will it be enough and what comes next? The answer may not be so easy to predict.
The global supply chain, which was rocked by the pandemic, is improving, but it’s still a factor. High energy prices are another major factor. The war between Russia and Ukraine has created a situation where more countries are chasing a single barrel of crude oil, contributing to price inflation. The latest CPI report showed that energy prices surged by more than 40%. This has a trickle-down effect on a variety of goods as it now takes more to make, grow, and ship them.
The situation leaves the Fed with little room to maneuver and it might be that raising rates high enough that the economy starts contracting is the only way to beat inflation. This is an idea that Fed chairman Powell seemed to acknowledge in recent remarks: “We actually think we need a period of growth below potential in order to create some slack.”
The contraction (or “growth below potential”) may already be happening, with preliminary Q2 GDP figures indicating the U.S. economy contracted by 0.9% on an annual basis. This would mark the second consecutive quarter of shrinking GDP and meet the generally accepted definition of a recession.