The Federal Reserve on Wednesday raised its benchmark interest rate by a half point for the first time in two decades as policymakers intensify their fight to cool red-hot inflation, a move that threatens to slow U.S. economic growth and exacerbate financial pressure on Americans.
The 50-basis point hike — a widely anticipated move — puts the key benchmark federal funds rate at a range between 0.75% to 1.0%, the highest since the pandemic began two years ago.
The Fed also announced that it will start reducing its massive $9 trillion balance sheet, which nearly doubled in size during the pandemic as the central bank bought mortgage-backed securities and other Treasurys to keep borrowing cheap. In a plan outlined Wednesday, the Fed indicated it will begin winding down the balance sheet June 1 at an initial combined monthly pace of $47.5 billion, a move that will further tighten credit for U.S. households. It will increase the run-off rate to $95 billion over three months.
Collectively, the steps mark the most aggressive tightening of monetary policy in decades as the Fed races to catch up with inflation, which hit a fresh 40-year high in March.
"Inflation is much too high," Fed Chairman Jerome Powell told reporters at a post-meeting news conference. "We understand the hardship it is causing, and we’re moving expeditiously to bring it back down. We have both the tools we need and the resolve that it will take to restore price stability on behalf of American families and businesses."
The question now is whether the Fed can successfully engineer the elusive soft landing — the sweet spot between tamping down demand to cool inflation without sending the economy into a downturn. Hiking interest rates tends to create higher rates on consumer and business loans, which slows the economy by forcing employers to cut back on spending
Powell indicated on Wednesday that policymakers want to front-load rate hikes in order to reach a neutral level that neither sustains nor hurts growth. He said that additional 50-basis point hikes are on the table in coming meetings but ruled out the possibility of an even bigger 75-basis point hike for now. Current market pricing shows that traders expect the rate to rise to 3% to 3.25% by the end of the year, according to CME Group data.
Stocks rallied about Powell rebuffed the possibility of a 75-basis point hike, with the S&P recording its best day since May 2020.
"With appropriate firming in the stance of monetary policy, the committee expects inflation to return to its 2% objective and the labor market to remain strong," the Fed said in its post-meeting statement. It noted the committee anticipates "that ongoing increases in the target range will be appropriate."
The Fed faced widespread criticism from economists who believe officials waited too long to act on inflation. There are now growing fears on Wall Street that central bank policymakers will fail to avoid a recession. Goldman Sachs, Bank of America and Deutsche Bank are among the firms forecasting a recession within the next two years.
Economic growth is already slowing, although consumer spending and business investment remain strong. Last week, the Bureau of Labor Statistics reported that the economy unexpectedly shrank in the first quarter of the year, marking the worst performance since the spring of 2020, when the U.S. economy was still deep in the throes of the COVID-induced recession.
Powell acknowledged there could be some "pain associated" with reducing inflation and curbing demand, but warned the bigger threat is entrenched inflation and pushed back against concerns of a looming downturn.
"It’s a strong economy," he said. "Nothing about it suggests it’s close to or vulnerable to a recession."