Interest Rate Activity and the Latest from the Fed

The U.S. Federal Reserve (“the Fed’) raised its benchmark interest rate by half a percentage point on May 4, a move previously cited as a consideration in the April 25 closed meeting of the Fed’s Board of Governors. As cited in April meeting, Chairman Powell indicated a primary reason for a rate increase would be to lower and manage inflation; again on May 4, U.S. inflation was again cited as a primary factor driving the interest hike decision. In contrast, deflation occurs when prices keep falling, convincing buyers to delay purchases as they wait for still lower prices.

Here are some observations pertaining to the Federal Reserve Open Market Committee’s (“FOMC’s/the Committee’s”) primary rationales for the May 4 rate increase.                                                         

The FOMC cited that although overall economic activity decreased in the 2022 first quarter, household spending and business fixed investment remained strong. Job gains have been robust in recent months, the unemployment rate has declined substantially, inflation remains elevated and reflects supply and demand imbalances related to the pandemic, energy prices are higher and broader price pressures continue. Also cited was the invasion of Ukraine by Russia and leading to uncertain implications for the U.S. economy. Additional upward pressure on inflation and COVID-related lockdowns in China are both likely to further disrupt supply chains.

The FOMC cited it is highly attentive to inflation risks.

• The Committee seeks to achieve maximum employment and inflation at the rate of 2% over the longer run. With appropriate firmness in the stance of monetary policy, the Committee expects inflation to return to its 2% objective and the labor market to remain strong. In support of these goals, the Committee decided to raise the target range for the federal funds rate from 0.75% to 1% and anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee decided to begin reducing its holdings of Treasury securities, agency debt and agency mortgage-backed securities on June 1, 2022, as described in the Plans for Reducing the Size of the Federal Reserve's Balance Sheet that were issued in conjunction with the FOMC statement.
• In assessing the appropriate stance of monetary policy, the Committee cited it will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee's assessments will consider a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.
• Examples of The Fed’s previous rationales for prior rate increases and decreases. As referenced in EisnerAmper’s comments of April 22, 2022, the Fed has demonstrated strong reactions to historic inflationary conditions.

In August 1971, when President Richard Nixon disengaged the dollar from the gold standard, and inflation increased from 4.7% to 12.3% in December 1974, the Fed increased the federal funds rate from 7% in March to 11% by August, and inflation continued to remain in double digits through April 1975. The Fed increased again the benchmark rate to 16% in March 1975, worsening the 1973 to 1975 recession, before reversing course and lowering the rate to 5.25% by April 1975. The all-time low for the federal funds rate is effectively zero. The federal funds rate reached a high of 20% in 1980 to combat double-digit inflation.

The Fed has twice lowered the rate to a range of 0.0% to 0.25%. The first time was during the financial crisis of 2008; the Fed didn't resume raising rates until December 2015. The lowest federal funds rate (before 2008) was in the range of 0.75% to 1.0% in 2003, in a move to combat the 2001 recession. There were fears that the economy was drifting toward deflation at that time.

Stay tuned for continued observations regarding Federal Reserve and FOMC guidance and initiatives as developments warrant.