FOMC frontloading rate hikes to battle inflation
Summary
On Wednesday, June 15, the Federal Open Market Committee (FOMC) voted 10 to 1 to raise the federal funds target range by 75 basis points to 1.50%-1.75%. This is the biggest rate hike by the Federal Reserve since 1994. They are also currently projecting seven more interest rate hikes in 2022 for a median target rate of 3.40%. The Federal Reserve Board stated they are “strongly committed” to returning inflation to 2% and will continue to raise rates as needed. Chair Powell does not expect 75 basis point hikes to be common, but the board is looking at an increase in July.
Key takeaways
- The Federal Reserve raised rates by 75 basis points for a target range of 150-175 bps. This is the largest rate hike since 1994.
- The market is pricing in a greater than 50% probability of another 75+ bps rate hike at July 26-27's FOMC meeting. The Fed’s newly released dot plot shows a median expected federal funds rate of 3.40% by the end of 2022 and 3.80% by the end of 2023.
- SOFR and LIBOR track the Fed Funds rate closely. Today’s 75 bps hike will drive a commensurate increase in current interest expense on unhedged floating-rate debt.
- The forward curves for 1-month Term SOFR shows this rate approaching 4.00% by April of 2023. If actual rates follow this path, it would represent a nearly 400 bps increase in base rates for floating-rate debt in just over one year.
- The cost of interest rate caps, which had already risen significantly from the start of the year, are up further in the past few days. Many common structures have increased in cost by 25% or more since the May 4 Fed meeting.
FOMC recap
The Federal Reserve voted 10 to 1 to increase the federal funds target range by 75 basis points, the largest increase since 1994. This increase comes on the heels of a larger than anticipated inflation report last Friday, June 10, 2022. The Federal Reserve Board remains highly attentive to inflation and is taking steps to help reduce inflationary pressures. The Federal Reserve will remain on course with their balance sheet run off program which began on June 1, 2022. Chairman Powell noted that the board understands the hardship that inflation is posing on Americans. The board is “highly attentive” to inflation pressures and will continue to monitor inflation indicators. Chairman Powell noted that the board is aiming to have rates in a restrictive territory by the end of this year. The board will hike rates in 50 basis point increments until they have evidence that inflation is under control. Powell noted that Russia-Ukraine war, COVID-19 lockdowns in China, and wage pressures are all factors impacting inflation.
Impact on rates
The board is going to remain hawkish in their approach to rate hikes, but Chairman Powell stated that 75 basis point hikes will not be the norm. The market instantly saw a drop in the expected forward curve to align closer with the 3.40% median fed funds target range at the end of the year (from 3.75% end of day yesterday). This decrease in expected rates also alleviated interest rate cap pricing as the market was previously pricing in multiple 75 basis point hikes.
Going forward
The Federal Reserve will remain highly attentive to inflation risks and wants to see indications that inflation is declining before they begin easing the rate increases. Chairman Powell noted that the board is looking to increase the fed funds target range by 50 to 75 basis points at the July meeting, which will bring the range to 200-250. The board believes the market is strong enough to withstand high interest rates. The Federal Reserve Board is expecting private goods to get increasingly expensive denoting the Russia-Ukraine war has exacerbated the commodities market. The market is currently pricing in a greater than 50% probability of a 75+ basis point hike at the July meeting. Floating-rate borrowers can expect consistent increases in interest rates in the near term with the Federal Reserve Board focusing on battling inflation.
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