Fed Adds 25 Basis Points to Federal Funds Rate

The Federal Open Market last week raised the federal funds rate by another 25 basis points, a move widely anticipated by analysts and financial markets.

The federal funds rate now stands at 4.75-5 percent, its highest rate since 2009.

The Fed noted job gains have picked up in recent months and are running at a robust pace and the unemployment rate has remained low. It acknowledged inflation “remains elevated.”

In a nod to bank turmoil over the past week, the FOMC insisted the U.S. banking system is “sound and resilient,” but noted “recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation. The extent of these effects is uncertain. The Committee remains highly attentive to inflation risks.”

Mike Fratantoni, Chief Economist with the Mortgage Bankers Association, said even with the heightened financial market volatility stemming from recent bank failures, the FOMC action represented a “’dovish hike,’ as the commentary and economic projections suggest we may be at or near the peak fed funds rate for this cycle.” 

“Inflation is still quite high, but it is slowing,” Fratantoni said. “And while the job market is still quite strong, it is weakening, as evidenced by slowing wage growth. Coupled with the advent of much tighter financial conditions after the events of the past couple of weeks, we are anticipating a much slower economy over the next few quarters — which should further bring down inflation per the Fed’s goal.”

Fratantoni note homebuyers in 2023 have shown themselves to be quite sensitive to any changes in mortgage rates. “With this move from the Federal Reserve, MBA is holding to its forecast that mortgage rates are likely to trend down over the course of this year, which should provide support for the purchase market,” he said. “The housing market was the first sector to slow as the result of tighter monetary policy and should be the first to benefit as policymakers slow – and ultimately stop – hiking rates.”

Fratantoni added the FOMC statement indicated an intent to continue quantitative tightening, allowing Treasury and Agency MBS to passively roll off the Fed’s balance sheet. “We expect that the recent increase in direct lending by the Fed through the discount window and the new term lending facility will help to improve liquidity for banks, despite this ongoing reduction in the size of the Fed’s securities holdings,” he said.

Odeta Kushi, Deputy Chief Economist with First American Financial Corp., Santa Ana, Calif., said while the Fed’s inflation fight continues, recent inflation data prompted many to think the Federal Reserve would inch the terminal rate higher, “the recent stress on the banking sector may be the reason for the unchanged terminal rate projection of 5.1%.”

“Real estate is a very interest rate-sensitive sector, which is why when the Fed first hit the proverbial brakes on the economy by hiking interest rates, the housing sector was the first to go through the windshield like a crash test dummy,” Kushi said. “As long as the Fed’s fight against inflation persists, it will continue to put downward pressure on the housing market because mortgage rates typically follow the same path as long-term bond yields, which move with inflation expectations and the Fed’s actions.”

Kushi noted the irony of the latest bank failures is that heightened investor uncertainty pushed investors to buy more Treasury bonds, resulting in declining yields on the 10-year Treasury, and a decrease in mortgage rates. “Lower mortgage rates, all else held equal, boost house-buying power,” she said. “An increase in affordability is good news for the housing market, especially heading into the housing market’s busiest season.”

“The fact that the Federal Reserve has decided to once again raise rates, albeit only 25-basis points, serves as further evidence that despite the consideration warranted to other real-time financial developments, and some positive signs in recent inflation reports, the Fed believes work remains to be done,” said Michele Raneri, vice president and head of U.S. research and consulting with TransUnion, Chicago. “From a consumer credit perspective, the impact of further rate hikes will likely continue to be felt by borrowers, particularly in industries such as mortgage and credit cards. In this high interest rate environment, consumers are advised to continue paying down as much higher interest debt as they can, continue paying bills on time, and work to keep their personal financial and credit profiles as strong as they can be.”

The full FOMC statement appears below:

“Recent indicators point to modest growth in spending and production. Job gains have picked up in recent months and are running at a robust pace; the unemployment rate has remained low. Inflation remains elevated.

“The U.S. banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation. The extent of these effects is uncertain. The Committee remains highly attentive to inflation risks.

“The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 4-3/4 to 5 percent. The Committee will closely monitor incoming information and assess the implications for monetary policy. The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the extent of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.

“In assessing the appropriate stance of monetary policy, the Committee 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 take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

“Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michael S. Barr; Michelle W. Bowman; Lisa D. Cook; Austan D. Goolsbee; Patrick Harker; Philip N. Jefferson; Neel Kashkari; Lorie K. Logan; and Christopher J. Waller.”