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Fed approves interest rate cut by half a point, stepping up its fight against inflation

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The Federal Reserve has approved a rare increase in interest rates by half a percentage point and announced plans to cut its asset portfolio by $ 9 trillion starting next month. double efforts to reduce inflation this is a maximum of four decades.

Walk, announced after a two-day policy at a meeting on Wednesday, will raise the central bank’s benchmark on federal funds to a target range of 0.75% to 1%.

Together steps note the most aggressive tightening of the Fed’s monetary policy at one meeting over the decades, aimed at rapidly reducing the economic stimulus that contributed to rising price pressure. The Fed, which typically raises interest rates by a quarter of a percent, last raised rates by half a point in 2000.

The Federal Open Market Rate Committee approved the decision unanimously. In a statement, the committee said it “predicts that a steady increase in the target range will be appropriate”, setting the stage for another big rate hike at a Fed meeting next month.

The statement cited the possibility of Covid-related failures in China sowing further chaos in global supply chains that could sustain inflation. “The Committee is very attentive to inflation risks,” the statement said.

The Fed has also finalized plans to start passively reducing its vast stocks of treasury and mortgage securities – that is, allowing bonds to maturity without reinvesting income in new securities rather than by selling them on the open market.

Officials will allow monthly in June, July and August to reduce to $ 30 billion in treasury bonds and $ 17.5 billion in mortgage bonds. They will then spend $ 60 billion a month on Treasury bonds and $ 35 billion on mortgage-backed securities.

Officials estimate that this process could allow up to $ 3 trillion in securities to fall out of the Fed’s portfolio over the next few years. They dramatically increased securities purchases in March and April 2020, when the pandemic shook the U.S. economy to stabilize dysfunctional financial markets, and then continued to buy assets to provide additional impetus to the economy.

Since the beginning of 2020, Fed mortgage and treasury securities have doubled to $ 2.7 trillion and nearly $ 5.8 trillion, respectively. Officials completed these purchases in March.

The main tool of the Federal Reserve to manage the economy is the rate on federal funds, which can affect not only the cost of borrowing for consumers, but also shape the decisions of companies, such as how many people to hire. The WSJ explains how the Fed manipulates this one rate. Illustration: Jacob Reynolds

The reverse expansion of the portfolio serves as an additional way to eliminate incentives and increase borrowing costs, although the exact magnitude of such tightening is difficult for politicians and economists to quantify.

As the Fed’s political decisions were so widely publicized on Wednesday, investors will focus on how Chairman Jerome Powell will describe the economic and political prospects at his press conference after the 14:30 Eastern time meeting.

The questions that most interest investors now twice. The former focus on tactical considerations in the short term as Fed officials race to catch up after repeated underestimation of inflationary pressures and the strength of domestic economic demand. Investors are trying to figure out how quickly the Fed can raise rates to a neutral level designed to slow growth, including what officials may need to accelerate rate increases to an even bigger step of 0.75 percentage points.

“The biggest challenge the Fed always has is to control the story of their plan to raise rates,” said Vincent Reinhart, a former senior Fed economist who is now chief economist at Dreyfus and Mellon.

Moving from a quarter point to a half point rate hike, “the risk is that investors are just stepping forward and expecting much more rigidity than the Fed is willing to give,” Mr Reinhart said.

Second, investors are looking for clues as to how high the Fed can raise rates. Now investors expect the Fed to raise rates by the end of next year to about 3.25%.

Between 2004 and 2006, the Fed raised the reference rate by 4.25 percentage points to a peak of 5.25%. Between 2015 and 2018, Fed officials raised rates from near zero to a range of 2.25% to 2.5% before Mr Powell signaled a sudden end in early 2019.

While short-term interest rates remain historically low, the central bank is signaling a path to raising rates that may be as aggressive as any since the 1980s.

Compared to that period, the Fed is now much more public about its political intentions. Such support is a serious reason that the cost of long-term loans, such as the 30-year mortgage rate, has jumped sharply since the beginning of the year, despite the fact that the Fed has only slightly raised the benchmark rate.

Because long-term interest rates are most important to economic activity – as opposed to the overnight rate set directly by the Fed – tightening policies occur when the price of investors changes in the future as long as the central bank meets those expectations.

The result is that the cost of loans for mortgages, car loans and business debt may begin to slow economic growth later this year. The average 30-year mortgage rate rose to 5.36% last week, up more than 2 percentage points from the end of last year, the Mortgage Bankers Association said on Wednesday. The trade group said that applications for mortgages to buy housing were 11% less than a week ago.

In the last 80 years, the Fed has never reduced inflation as much as it intends to do now – by 4 percentage points – without causing a recession. In this case, the central bank will need a number of factors beyond its control to break the road.

In March, representatives of the Fed for the first time raised rates after lowering them to almost zero when the pandemic struck two years earlier. Officials’ forecasts in March suggested that they could raise rates at each meeting this year and several more times next year to about 2.75% – a level estimated to be in a neutral range designed to neither stimulate nor slow economic growth. They predicted that over the next three years, inflation would gradually drop to just above their 2% target.

Some economists say the Fed will have to raise rates just to maintain a neutral environment because core inflation has risen. In March, consumer prices rose 6.6%. the year before – as measured by the Fed’s overwhelming inflation rate, the Ministry of Commerce’s personal consumer price index – to a new four-decade high. A separate measure derived from this Dallas Fed index, which excludes the most volatile elements for measuring base price pressure, rose 3.7% in March.

Demand has been driven by low interest rates and government borrowing and spending of $ 6.4 trillion since the Covid-19 strike. Businesses and households spent money faster than a pandemic-stricken economy could supply goods and services, so prices soared. Initially, the Fed believed last year that inflation would ease on its own, but Mr Powell turned in November amid signs of growing labor market imbalances.

Fed officials expect inflation to fall this year as supply chains stop deteriorating, but war in Ukraine and sanctions against Russia by the West pushed up prices for food, energy and raw materials. New blockades in China threaten to exacerbate supply bottlenecks.

Domestic inflation sources may keep inflation high in the coming months as tougher labor markets and lower vacancies push up wages and rents, two sources of inflation that tend to be more resilient and harder to squeeze out of the economy. recession.

Unemployment rate in March fell to 3.6%, about the half-century low recorded before the pandemic hit the US. Last week, the Ministry of Labor’s wage measurement showed that wages and benefits for private sector workers continue to grow at the highest rate in two decades.

Write Nick Timiraas on nick.timiraos@wsj.com

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