The Federal Reserve has indicated that it will raise interest rates once more this year and reduce the pace of cuts in 2024, as the US economy shows signs of resilience amid the Covid-19 pandemic.
Fed holds rates steady at 22-year high
The Fed kept its benchmark interest rate unchanged at 5.25 percent on Wednesday, after raising it four times in 2023. The rate is the highest since June 2001, when the Fed last cut rates before the 9/11 attacks.
The Fed said that the economy has made progress towards its goals of maximum employment and price stability, but that some risks remain, such as the spread of new variants of the coronavirus and supply chain disruptions.
The Fed also said that it will continue to reduce its monthly bond purchases by $15 billion, starting in October, until it reaches zero by mid-2024. The bond purchases, which began in March 2020, were aimed at supporting the financial markets and the economy during the pandemic.
Fed signals one more hike in 2023 and fewer cuts in 2024
The Fed’s projections for future interest rates, known as the dot plot, showed that most officials expect one more rate hike in 2023, bringing the rate to 5.5 percent by the end of the year. This is unchanged from the previous dot plot in June.
However, the Fed also signalled that it will cut rates less aggressively in 2024, with only two reductions expected, compared to four in June. The median projection for the rate at the end of 2024 is now 4.75 percent, down from 5 percent in June.
The Fed’s outlook reflects its confidence that the economy will continue to recover from the pandemic, despite some headwinds. The Fed expects the GDP growth to slow down from 6 percent in 2023 to 3.8 percent in 2024, but still above the long-run potential of 1.8 percent. The Fed also expects the unemployment rate to fall from 4.8 percent in 2023 to 3.5 percent in 2024, matching the pre-pandemic level. The Fed also expects inflation to moderate from 4.2 percent in 2023 to 2.2 percent in 2024, close to its target of 2 percent.
Market reaction and implications
The US stock market fell after the Fed’s announcement, as investors anticipated higher borrowing costs and lower corporate profits. The S&P 500 index dropped by 0.6 percent, while the Nasdaq composite index fell by 0.8 percent.
The US dollar strengthened against other major currencies, as higher interest rates make it more attractive for investors. The euro fell by 0.4 percent against the dollar, while the yen declined by 0.3 percent.
The US bond market also reacted to the Fed’s signals, with longer-term yields rising and shorter-term yields falling. This means that the yield curve, which measures the difference between long-term and short-term interest rates, flattened. A flatter yield curve suggests that investors expect slower economic growth and lower inflation in the future.
The Fed’s decision and guidance have important implications for the US economy and the global financial system. Higher interest rates could dampen consumer spending and business investment, which are the main drivers of economic growth. Higher interest rates could also increase the debt burden for households and firms, especially those with variable-rate loans or mortgages.
On the other hand, higher interest rates could help contain inflationary pressures and prevent overheating of the economy. Higher interest rates could also boost confidence and credibility of the Fed, which has been under criticism for being too dovish and behind the curve.