Fed Raises Interest Rates to Highest Level in 22 Years

Federal Reserve Board Chairman Jerome Powell speaks during a news conference following a Federal Open Market Committee meeting at the Federal Reserve in Washington on July 26, 2023. Saul Loeb/AFP via Getty Images

The Federal Reserve raised the federal funds rate by 25 basis points at the July Federal Open Market Committee (FOMC) policy meeting, lifting the target range to 5.25–5.50 percent. Rate-setting Committee members voted unanimously for the policy decision.

Interest rates are now at their highest levels since March 2001.

“Recent indicators suggest that economic activity has been expanding at a moderate pace. Job gains have been robust in recent months, and the unemployment rate has remained low,” the FOMC stated. “The U.S. banking system is sound and resilient. Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain.”

Policymakers may consider additional monetary firming to curb inflation, the FOMC noted.

“The Committee will continue to assess additional information and its implications for monetary policy,” the FOMC stated.

Moreover, the FOMC will stay the course on reducing the $8.3 trillion balance sheet that includes holdings of Treasury securities, agency debt, and mortgage-backed securities.

The U.S. financial markets were relatively unchanged following the rate decision, with the leading benchmark indexes teetering between positive and negative territory.

Treasury yields were mixed, with the benchmark 10-year yield down more than 2 basis points to below 3.89 percent. The 2-month yield picked up nearly 2 basis points to above 5.42 percent.

The U.S. Dollar Index, a gauge of the greenback against a basket of currencies, fell to about 101.20.

After 10 consecutive rate hikes that increased the benchmark rate by 500 basis points, the Fed skipped a rate hike at the June FOMC meeting.

The futures market had largely expected a quarter-point increase in the terminal rate. But investors are now debating whether the central bank will follow through on the June Summary of Economic Projections data (pdf) that showed that officials were anticipating two more rate hikes this year.

Next Steps for the Fed

Speaking at the post-FOMC meeting press conference, Fed Chairman Jerome Powell told reporters that the rate-setting Committee would adopt a meeting-by-meeting, data-dependent approach toward future increases.

Although inflation has moderated somewhat, the U.S. central bank chief conceded that returning inflation to the Fed’s 2 percent target “has a long way to go.” However, the institution hasn’t confirmed any policy decision for the upcoming meetings, alluding to a treasure trove of data, including two jobs reports, two consumer price index (CPI) readings, employment compensation, and other key measurements for the overall economy.

“I would say it is certainly possible that we would raise funds again at the September meeting if the data warranted it,” Mr. Powell said. “And I would also say it’s possible that we would choose to hold steady at that meeting.”

Market analysts have said that the Fed’s course is uncertain because of various factors.

Fed officials say inflation is too high, but many metrics suggest that price pressures are slowing. In June, the CPI eased to 3 percent, the lowest level since March 2021 and far below the peak of 9.1 percent in June 2022.

There are concerns that the central bank could overtighten and risk sending the United States into a downturn. Mr. Powell said he still envisions a soft landing, but a chorus of economists warn that the institution could break the economy by raising interest rates too high.

“The end is near. The manufacturing sector is shrinking, the service sector is cooling, inflation is below the fed funds rate and declining,” Bryce Doty, senior vice president and senior portfolio manager at Sit Investments, said in a note. “As savings dry up and the workforce grows, supply constraints are less and less common, allowing inflation pressures to subside. As a result, the Fed no longer needs to keep raising interest rates ... but they will anyway.”

The S&P Global Manufacturing Purchasing Managers’ Index (PMI) has been in contraction for eight of the past nine months, touching 49 in July. In addition, the S&P Global Services PMI slowed to 52.4 this month, down from 54.4 in June.

A recent research paper by Fed economists concluded that the savings accumulated during the coronavirus pandemic have been exhausted, resulting in a below-trend savings rate.

Investors are also debating what the Fed will do next. According to the CME FedWatch Tool, traders are betting that the Fed will hit a pause at the September, November, and December policy meetings.

“There is more and more chatter—pundits, academics, and dovish Fed members—that the Fed should tolerate and will tolerate higher-for-longer inflation to preserve jobs and growth,” said Ali Hassan, a portfolio manager at Thornburg Investment Management. “After all, as inflation drops, real rates will be tightening.”

Still, there is plenty of uncertainty regarding the outlook for the next meeting, let alone next year. But, according to Mr. Powell, it’s certain that the Fed won’t be slashing interest rates this year.

With inflation unlikely to reach 2 percent until 2025, the Fed may or may not start cutting interest rates before the goal is reached, he said.

This is a breaking news story; check back for future developments.