United States: Fed continues to hike in May; announces balance sheet shrinkage
At its meeting on 3–4 May, the Federal Open Market Committee (FOMC) decided to raise the target range for the federal funds rate to 0.75–1.00%, in line with market expectations. The Fed also announced it would begin reducing the size of its balance sheet from 1 June by not reinvesting all maturing assets.
The Fed’s decision to raise rates was driven by the desire to tame inflation—which has been running above the target rate of 2.0% since early 2021—and keep a lid on inflation expectations. While some sources of inflation are external, such as the war in Ukraine and global supply constraints, the red-hot domestic labor market is also generating price pressures. Moreover, strong activity at home provided room for the Fed to hike without severely weakening the economy.
Looking forward, the Fed said it “anticipates that ongoing increases in the target range will be appropriate”. Most panelists see another 50 basis-point hike in June, followed by several additional rate hikes in H2 as the Central Bank tries to get a grip on inflation. Given that inflation is likely on a downward—albeit gradual—trend, rate hikes of greater than 50 basis points are not expected.
On the outlook, ING’s James Knightley said:
“The Fed will hike by 50bp at June, July and September […]. We expect the Bank to switch to 25bp increments in the final meetings of 2022 when quantitative tightening is fully up to speed and contributes to the tighter monetary conditions.”
Analysts at Nomura took a similar view:
“We have adjusted our near-term Fed call and no longer expect the FOMC to raise rates by 75bp in June and July; we now think the Fed will opt for three additional 50bp hikes (in June, July and September). We do not believe the recent softening in economic data will derail a fourth 50bp hike at the September meeting considering our near-term inflation forecast.”
The next FOMC meeting is scheduled for 14–15 June.