The day after the Federal Reserve announced their largest rate increase in almost 40 years, which was specifically intended to combat the United States' escalating inflation, stock markets crashed.
The federal funds rate was increased by 75 basis points (bps) by the Federal Open Market Committee (FOMC), the largest single rise since November 1994. The fed funds rate increased to a range of 1.5 percent to 1.75 percent as a result of this historic decision.
As of midday, the tech-heavy Nasdaq Composite is down roughly 3.7 percent, the Dow Jones Industrial Average (DJIA) is down about 2.0 percent, and the S&P 500 is down 2.8 percent.
After the judgement, Treasury rates quickly increased, albeit they have since fallen from their peak levels. The benchmark 10-year yield is at 3.34 percent, while the 2-year yield is at 3.18 percent.
The Fed Takes Inflation Seriously:
Prior to yesterday's decision, anticipation for a larger Fed rate increase had sharply increased. In accordance with Fed Chair Powell's remarks from the March meeting, the overwhelming expectation heading into June was that the Fed would announce another 50 basis point rate increase.
Then, optimism that inflation was slowing were shattered by the Consumer Price Index (CPI) report for May. According to the figures, inflation unexpectedly picked up in May, increasing by 8.6 percent year over year, the highest level since 1981. Hopes that price hikes were slowing down were raised by the April CPI reading.
Market expectations began pricing in a 75 basis point hike seemingly overnight, and the Fed did not disappoint. Analysts may have hailed the larger move as evidence that the Fed is finally taking action to combat inflation, but the underlying worry is that the central bank has allowed the issue to spiral out of hand.
According to Brad Conger, deputy CIO of Hirtle Callaghan & Co., "the fatal error of the last year was not changing rates sooner to create more breathing space for future meetings." The FOMC is now forced to react automatically to inflation statistics. 3.80 percent is still the terminal Fed Funds rate.
Fuel for the fire came from an updated Summary of Economic Projections (SEP), which showed that Fed officials had revised down their expectation for the GDP in 2022 from +2.8 percent to +1.7 percent. Fed officials predict a GDP growth rate of +1.7 percent for 2023, down from +2.2 percent in March.
Powell asserted that "the economy is well positioned to handle tighter policy" at the news conference following the decision. Markets have less confidence in that.
According to Bill Adams, chief economist at Comerica Bank, "if inflation continues to surprise to the upside they are likely to tighten more than they presently think is prudent." On the other hand, if the current downturn in the economy turns into a full-fledged recession, which would result in a drop in home prices, the Fed may raise interest rates less than anticipated or begin cutting them sooner than anticipated.
Rate Increases Will Persist Until Morale Rises:
In just one or two trading sessions, the mood of the stock market can change suddenly from extreme optimism to manic depression episodes. That undoubtedly accounts for the recent movements.
The verdict on Wednesday sparked a market rally, which helped the session end with a significant gain. But this morning, the selling came back with a fury.
The target rate for federal funds would be between 2.25 percent and 2.5 percent if additional 75 basis points were added to the current rate at the upcoming Federal Open Market Committee (FOMC) meeting, which is planned for July 26–27.
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