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Saying the war in Ukraine is causing not only “tremendous human and economic hardship” but driving inflation, the Federal Reserve approved its fourth 75-basis point rate hike of the year Wednesday, but signaled it could make smaller increases going forward.
The Fed has raised the federal funds overnight rate six times this year, bringing the benchmark rate to a target range of 3.75 to 4 percent. While the Fed started with a modest 25-basis point increase on March 17, it has made more drastic hikes as inflation has shown few signs of moderating.
Russia’s Feb. 24 invasion of Ukraine has driven up prices for energy and food and created upward pressure on inflation, Federal Reserve Chairman Jerome Powell said at a press conference. While the pace of rate hikes could slow, they may ultimately need to go higher than forecast in September, he said.
“At some point, as I’ve said in the last two press conferences, it will become appropriate to slow the pace of increases to bring inflation down to our 2 percent goal,” Powell said. But the Fed is grappling not only with how fast to raise the federal funds rate but how high and for how long.
The “dot plot” gauging the collective views of Fed policymakers in September showed members of the Federal Open Market Committee expected they’ll need to bring the federal funds rate to 4.6 percent by the end of next year to tame inflation.
Since the Fed’s last meeting, incoming data on labor and consumer prices “suggest to me that we may move to higher levels than we thought at the time of the September meeting,” Powell said. “That level is very uncertain, though. I would say we’re going to find it over time.”
If the ultimate target for the federal funds rate has been raised, one question becomes whether the Fed implements another 75-basis point increase next month at its final meeting of the year or approves a more modest 50-basis point increase.
The CME FedWatch Tool, which monitors futures contracts to calculate the probability of Fed rate hikes, shows traders on Wednesday were pricing in a 43 percent chance of another 75-basis point rate hike on Dec. 14.
But to Powell, the size of next month’s rate hike is not the most important question.
“To be clear … the question of when to moderate the pace of increases is now much less important than the question of how high to raise rates and how long to keep monetary policy restrictive, which will be our principle focus,” Powell said.
Today’s announcement “is not a shift in policy,” KPMG Chief Economist Diane Swonk tweeted. “It is consistent with everything the Fed has said.”
The Fed is “still committed to rate hikes but front-loading is for [the] moment behind us,” Swonk summarized. “We are in restrictive territory and financial conditions have [tightened]. Fed not pivoting but calibrating.”
Although the Fed doesn’t have direct control over mortgage rates, yields on long-term Treasurys have climbed in concert with the short-term federal funds rate. And mortgage rates have gone up even more — in part because of bond market investors’ worries about prepayment risk.
Investors who fund mortgages are demanding an unusually high premium in comparison to comparable government bonds out of fears that the home loans they make now could quickly be refinanced if rates drop, the Urban Institute’s Laurie Goodman tweeted.
“With dramatic rate hikes, the ‘mortgage spread’ — or the difference between the rate on 30-year fixed-rate amortizing mortgages and 10-year Treasury notes, two instruments with comparable price sensitivity — has widened considerably.”
If mortgage rates had risen the same amount as Treasury rates, “the current mortgage rate would be well under 6 percent rather than pushing 7 percent,” Goodman noted.
In many markets, the rapid run-up in mortgage prices has had a dramatic effect on home sales, inventories and prices.
Powell said the Fed is “well aware of what’s going on” in housing. While housing “doesn’t appear to present financial stability issues … we do understand that’s where a really big effect of our policies is,” he said.
“The housing market was very overheated for a couple years after the pandemic as demand increased and rates were low,” Powell said at a press conference. ” We all know the stories of how overheated the housing market was. Pricing going up, many, many bidders, no conditions. The housing market needs to get back into a balance between supply and demand.”