The Fed raises interest rates another quarter point

As widely expected, today’s Fed statement confirmed that policymakers are still firmly committed to doing what they believe is needed to return inflation to their 2% target.

Based on what they’ve seen and said today, they may not be done yet.

The Fed announced a quarter-point rate hike, lifting their benchmark interest rate to a range of 5.0 – 5.25%, the first time since before the global financial crisis that the funds rate has been that high. The move completes a round trip for monetary policy that took interest rates to zero to stimulate the economy in the aftermath of the worst global economic crisis since the Great Depression and again to provide support for an economy that shut down virtually overnight in the early days of the COVID-19 pandemic.

The Fed’s statement was similar in tone to their June comments, with perhaps the most notable change being a nuanced change in tone in their assessment of the economic expansion from “modest” to “moderate.”

No updated forecasts accompanied the statement, but the subtle shift in tone suggests that economic momentum is persisting (if not modestly accelerating) to a degree that exceeds their prior forecasts. Against that backdrop, it wouldn’t be surprising for the Fed to tighten further beyond today’s rate hike.

In his press conference, Fed Chair Jay Powell reiterated the Fed’s data dependency, suggesting that there’s not a preordained path for rates from here. Incoming data related to the relative strength of growth, labor market conditions, and price pressures will all matter in their September decision.

One key component to the Fed’s prescription to stabilize prices is a fairly pronounced easing in labor market conditions. While job creation has slowed this year and other gauges of labor market strength have moderated, the unemployment rate has held firm near its half-century low. Tight labor market conditions have created a highly competitive hiring environment in recent years, lifting wages across the country. That creates a risk that isn’t lost on policymakers.

Most measures of inflation expectations remain well anchored, reflecting a general belief that surging prices are a temporary phenomenon and that the combination of Fed policy and market forces will ultimately result in a return to a more normal inflation environment.

Even so, the Fed appears to still believe that unemployment will need to rise to avoid a potential wage price spiral and feel confident that they’ve done enough to meet their inflation mandate.

The wild card is the proverbial “long and variable lag” of monetary policy, recognizing that there’s no iron-clad formula to determine how rapidly inflation should recede or how high rates must go. That leaves a great deal of judgment for the Fed to accomplish their employment and inflation goals without tipping the economy into recession.

Much of the impact of the Fed’s cumulative hikes hasn’t yet been fully realized in the economy. That delayed impact makes ongoing rate hike decisions more difficult as they attempt to weigh the risk of doing too little with that of doing too much.

The bottom line? Today’s rate hike decision was expected, and some degree of additional tightening in the coming months shouldn’t be a surprise. The Fed may end up doing too much. But make no mistake — policymakers still see inflation as the primary risk and will do whatever is needed to bring it down toward the central bank’s 2% target.