The Federal Reserve hiked its target federal funds rate by 0.75% on Wednesday. Here’s what it means for the markets.
The market rallied Wednesday after the Federal Reserve hiked its federal funds rate target by 0.75 percentage points. The increase marks the largest single jump since November 1994. Wednesday’s Fed hike is the third (and largest) this year as the Federal Reserve attempts to wrangle sky-high inflation under control. In a statement, the Federal Reserve cited elevated inflation driven by supply chain pressure, the war in Ukraine and Covid-19 lockdowns in China as major factors in its decision. Following the Federal Open Market Committee’s meeting, Fed Chair Jerome Powell acknowledged in a press conference that high inflation continues to cause “hardship.” However, he further admitted that the Fed’s ability to bring inflation down without causing a recession depends on “many factors that we don’t control.”
Meanwhile, economists have become increasingly pessimistic about the Fed bringing the economy in for a “soft landing.” For instance, a Financial Times survey found that most economists expect a recession next year. And in a client note, Wells Fargo wrote that they “judge that recession next year is more likely than not.”
Before we dive into what this means for consumers and investors, let’s have a quick refresher on what Fed hikes do. The Fed controls the federal target funds rate, which determines how much interest banks pay to borrow overnight. While consumers don’t pay this rate directly, increasing the federal funds rate often increases other interest rates, too. By raising the funds rate, the Federal Reserve can increase the cost of borrowing money for consumers and businesses alike. This curtails Americans’ willingness – and often ability – to spend money. As a result, demand drops, and with it, prices. Through this mechanism, the Fed’s rate hikes are one of the most effective tools it has to fight high inflation. That said, it often comes with unfortunate side effects, such as higher unemployment and even the chance of recession.
