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Federal Reserve policymakers voted Wednesday not to raise a key benchmark interest rate this month, but Fed Chair Jerome Powell warned that future rate hikes are likely if the economy doesn’t continue to cool.
Powell’s hawkish remarks on the Fed’s determination to rein in inflation could keep mortgage rates elevated and lending standards tight. Since early last year, Fed policymakers have raised the federal funds rate by five percentage points and continue to trim the Fed’s massive holdings of Treasurys and mortgage-backed securities by $95 billion a month, Powell noted.
“We’ve covered a lot of ground,” Powell told reporters at a press conference following the Federal Open Market Committee’s latest meeting. “The full effects have yet to be felt. In light of how far we’ve come in tightening policy, the uncertain lags with which monetary policy affects the economy, and potential headwinds from credit tightening, today we decided to leave our policy interest rate unchanged and continue to reduce our securities. Nearly all participants think further rate changes will be necessary.”
In a statement explaining their unanimous vote to keep the benchmark federal funds rate at the current target range of 5.0 to 5.25 percent, members of the Federal Open Market Committee said they are “strongly committed to returning inflation to its 2 percent objective.”
While the U.S. banking system is “sound and resilient,” tighter credit conditions for households and businesses “are likely to weigh on economic activity, hiring, and inflation,” the statement reads. “The extent of these effects remains uncertain. The committee remains highly attentive to inflation risks.”
Yields on 10-year Treasury notes, which often indicate where mortgage rates are headed next, initially surged after the Federal Open Market Committee’s vote and Powell’s hawkish comments. But bond yields retreated and stocks recovered some losses as Powell explained that no decision on future rate hikes has been made.
“It may make sense for rates to move higher, but at a more moderate pace,” Powell said. “I want to stress one more thing, and that is that the committee decision made today was only about this meeting. We didn’t make any decision about going forward, including what would happen at the next meeting. We did not decide or really discuss anything about going to an [approach of raising rates at] every other meeting… or any other approach.”
Hiking rates to fight inflation
In the hopes of cooling the economy, Fed policymakers have approved 10 increases in the federal funds rate since March 2022. That’s brought the short-term benchmark rate to a target of between 5 percent and 5.25 percent.
Last year the Fed was hiking rates in increments of 50- and 75-basis points or half to three-quarters of a percentage point at a time. As the Fed gets closer to bringing the short-term benchmark to where it thinks it should be to bring inflation down, policymakers began approving smaller, 25-basis point increases in February, March and May.
Fed policymakers issued a summary of economic projections and their so-called “dot plot” after Wednesday’s meeting, showing most members of the Federal Open Market Committee are inclined to implement two more 25-basis point rate hikes this year — a move some economists think could tilt the economy into a recession.
Mike Fratantoni
“The new set of economic projections shows that the median FOMC member expects two additional hikes by the end of 2023,” Mortgage Bankers Association Chief Economist Mike Fratantoni said in a statement. “Unfortunately, this only adds to the chances that the economy will slow sharply.
“Given the banking challenges that have already resulted in a tight credit environment, the threat of further hikes, baked in to medium-term rates today, will only further slow economic activity. We expect that economic conditions will develop in such a way that further hikes are not needed, but this new information impacts markets immediately.”
Inflation down by more than half from peak
The latest Consumer Price Index report shows inflation is down by more than half from peak with the annual increase in CPI falling to 4 percent in May, down from a peak for this century of 9.1 percent in June 2022. That’s still far above Fed policymakers’ long-term goal of bringing inflation down to 2 percent.
The MBA reported this week that standards for home loans tightened for the third month in a row in May, with mortgage credit availability falling to the lowest level since January 2013.
Fratantoni said while inflation is coming down slowly, “multiple indicators” here and abroad suggest the economy will “slow significantly” in the near term. Recent strength in job markets has muddled the picture, so it’s not surprising that Fed policymakers refrained from hiking rates this month, while keeping their options open for rate increases in July and later this year. But Fratantoni said MBA forecasters believe the Fed is done hiking rates.
“Mortgage rates have generally increased in the past month, and this has slowed the pace of housing market activity, as potential homebuyers have been very sensitive to any changes in rates this year,” Fratantoni noted. “We expect that mortgage rates will drift down over the second half of the year as the economy slows and the Fed reacts accordingly by holding off on further rate hikes.”
Pantheon Macroeconomics Chief Economist Ian Shepherdson agreed that “Two more hikes this year looks excessive and unlikely.”
In a note to clients, Shepherdson said there’s “a decent chance that a July hike will be avoided, but it will be very close. By September, we think the case for further hikes will have weakened markedly, so a July hike will be the last.”
Powell acknowledged that housing is “very interest-sensitive and it’s the first place really, one of the first places that’s either helped by low rates or that is held back by higher rates. And we certainly saw that over the course of last year.”
Fed analysts now see housing “putting in the bottom and maybe moving up a little bit,” Powell said. “We’re watching that situation carefully. I do think we will see rents and house prices filtering into housing services inflation. And I don’t see them coming up quickly. I do see them wandering around at a relatively low level now. And that’s appropriate.”
Odds of future rate increases
Target rate probabilities for Dec. 13 Federal Open Market Committee meeting | Source: CME FedWatch Tool
The CME FedWatch Tool, which monitors futures markets to gauge investor sentiment of the Fed’s next moves, puts the odds that the federal funds rate will be higher at the end of the year than it is today at 55 percent.
Futures markets are pricing in a 35 percent chance that the federal funds end the year where it is today, between 5.0 and 5.25 percent, and a 45 percent chance that rates will be 25 basis points higher. Futures markets predict only a 10 percent chance that rates will be 50 basis points higher at the end of the year.
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