US Fed moderates interest hike rate

The US Fed Reserve has raised the interest rate by 25 percentage points, from 4.5 per cent to 4.75 per cent, which is modest in comparison to the series of rate hikes in 2022. Fed Reserve chairman Jeremy Powell said that the interest rate hike would continue but in small doses until the inflation rate returns to the mandated 2 per cent. The inflation rate is now at 5 per cent, less than the 7 per cent earlier. Powell is of the view that inflation remains at an elevated level, and there is no room for complacency. The markets fear rate hike-induced recession but Powell sticks to the view that inflation cannot be allowed to be at the high levels that it is now at.

Beating the prediction of recession as it were, the US economic growth rate in the last quarter was promising at 4 per cent, and unemployment rate was at a low 3.5 per cent. While market watchers feel that the growth rate is good news and that inflation is no more the threat it appeared to be through last year, the Fed Reserve does not agree, and it holds to its view that there is need to tame inflation further.

The Fed in its statement said, “The Federal (Open Market Committee) anticipates that ongoing increases in the target ranges would be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 per cent over time.” US Commerce Department data showed that consumer spending in the last two months of 2022 was lower than the year before, and prices too are coming down, showing that the Fed’s policy of rate hike is having its impact.

The American stock markets have bounced back, and The Wall Street Journal, the leading business newspaper in America headlined, “Stock, Bond, Crypto Investors Call Federal’s Bluff on Interest Rates”, which suggested that the much-feared recession did not happen despite the Fed’s persistent hike in interest rates through 2022. Non-profitable technology companies, a list compiled by Goldman Sachs, bounced 28 per cent after the steep fall in 2022, and cryptocurrencies staged a 43 per cent recovery. As far as the American markets are concerned, this is a huge vote of confidence in the American economy and fears of recession have been pushed back decisively.

While from the American viewpoints the interest rate hike might be seen as the right policy correction, the impact on other economies seems to be negative in many aspects.

This is so especially with the emerging market economies (EMEs) because these countries experienced capital flight from their countries drawn by a stronger dollar. It also meant that the currencies of the EMEs depreciated against the dollar.

The lowering of the interest rate would mean that there would be a reversal of fund flows. It would also improve the exports from developing countries, including the EMEs. There is however the apprehension that the Russia-Ukraine war, which has hiked the oil prices and also the rate of inflation, remains an area of concern.

It seems to be the case that inflation in the US could be attributed to the interruption caused by the COVID-19 pandemic in 2020-21, and the government had to pay for the social security as well as additional financial support to affected families.

Evidence suggested that the pandemic time helped many of the debt-strapped families to pay their debts. But the government expenditure ballooned and it is one of the indirect causes of high inflation.

And for a brief period in 2022, the US experiences shortfall of labour. As the US economy went through these shock effects, inflation began to rise at an alarming rate, forcing the Fed to resort to rate hikes.