Federal Reserve Set to Raise Interest Rates Amid Economic Growth and Inflation Uncertainties

The Federal Reserve is gearing up to raise interest rates by a quarter-percentage point on Wednesday, reaching the highest rate in 22 years.

While investors are keenly anticipating the rate hike, they are also closely watching for signals on whether this increase will mark the end of the current tightening cycle or if further rate adjustments are on the horizon. Economic growth in recent months has been robust, making it difficult for Fed Chair Jerome Powell to suggest that the upcoming rate hike will be the last. Additionally, the recent slowdown in inflation poses challenges for the central bank in firming up plans for any additional rate increases.

The Federal Reserve's decision on interest rates will be revealed at 2 p.m. Eastern time, followed by a press conference by Jerome Powell at 2:30 p.m. However, unlike previous meetings, the central bank will not release quarterly interest-rate and economic projections after this week's two-day meeting.

The interest rate hike comes after the Federal Reserve's decision to hold interest rates steady in a range between 5% and 5.25% last month, which marked the first pause after ten consecutive increases since March 2022 when rates were raised from near zero. The primary aim of raising interest rates is to slow down the economy through financial markets by lowering asset prices and increasing borrowing costs.

Despite some improvements in inflation data this month, the Federal Reserve remains motivated to proceed with the rate increase this week. The central bank is driven by stronger-than-anticipated overall hiring and economic activity since May. Moreover, some officials within the Federal Reserve are inclined to wait for further evidence of inflation continuing to ease before concluding the rate hike cycle.

The recent consumer-price index for core inflation, excluding volatile food and energy prices, showed its smallest monthly increase in over two years in June, rising by less than 0.2% from the prior month.

Federal Reserve Governor Christopher Waller, in a July speech, emphasized the need for evidence that the recent slowdown in inflation is not a temporary occurrence. He stated, "The recent report warmed my heart, but…I’ve got to make policy with my head. And I can’t do that on one data point."

Regarding the path for future rate increases, most Federal Reserve officials projected two more rate rises for this year during the June meeting. Investors are closely analyzing Powell's press conference for indications of whether the next Fed meeting in September is "live," meaning a rate increase will be strongly considered. Additionally, they are looking for clues on whether the central bank might be comfortable pausing rate hikes in September and waiting longer to assess economic developments.

Powell previously framed the decision to pause interest rate increases in June as an effort to allow officials more time to study the impact of past rate adjustments. The pace of future rate increases, whether consecutive or on a slower, quarterly basis, will be contingent on the evolving economic conditions.

The outlook for inflation is a critical factor of interest for investors. They want to know whether the recent data, such as the June consumer-price index, would be sufficient for officials to revise their inflation forecast. Fed officials have been relying on a slowdown in core inflation, especially in goods and shelter prices, to shape their policy decisions. Further progress on inflation may not substantially alter the path of interest rates.

William English, a former senior Fed economist and a professor at Yale School of Management, remarked that additional improvements in inflation "may not be much of a surprise, and it wouldn’t have a big effect on where policy should go."

Lastly, the Federal Reserve is also keeping a close eye on the labor market. Officials seek evidence that economic activity, hiring, and wage growth are decelerating, even if inflation eases at a faster rate than initially projected during the June meeting. However, determining the threshold of evidence required for further rate adjustments remains an open question.

The Federal Reserve's decisions and statements during this critical period will carry significant implications for financial markets and the broader economy. Investors and market participants are closely monitoring the central bank's approach to managing economic growth and inflation as they navigate the intricacies of monetary policy and market dynamics.

By fLEXI tEAM