US FED raised its benchmark federal-funds rate by three-quarters of a percentage point

The US Federal Reserve officials voted to raise interest rates by three-quarters of a percentage point (75bps) and signaled four more agressive rate hikes toward yearend to combat inflation which is running at a 40-year high (+8.6% YoY in May 2022). Besides that, in economic projections released, the FED policymaker expected to raise median FFR in 2022 to 3.4% (vs 1.9% in March 2022) and suggested another 1.75% in total rate hikes, spread across the remaining four scheduled FOMC toward the end of 2022. In addition, FED’s economic projections aslo expected the US economy will only grow by 1.7%YoY this year (vs forecasted +2.8%YoY in March 2022) and prices, as measured by personal consumption expenditures (PCE), to rise by 5.2% over the course of 2022 (faster than 4.3% forecasted in March 2022). 

Furthermore, the FED also announced its Quantitative Tightening program in FOMC meeting in 4-5 May 2022. The FED will begin allowing its Federal Reserve’s securities holdings to decline in June 2022 at an initial combined monthly pace of USD47.5bn (USD30bn per month for Treasury securities and USD17.5bn for agency debt and agency mortgage-backed securities) and stepping up over three months to USD95bn (USD30bn per month for Treasury securities and USD35bn for agency debt and agency mortgage-backed securities). With this plan, FED expected to reduce around USD400bn of its balance sheet by the end of 2022 (decreased roughly 10% of over USD4.6tn increased in FED balance sheet during March 2020 to May 2022). In addition, ECB also plans to follow FED with its Quantitative Tightening program and also signaled to raise interest rate by half percentage point (50bps) in July 2022. 

In our opinion, recent inflation was coming from 

(1) monetary-related inflation caused by sustained increase in the money supply of various countries over 2020-2021 period; 

(2) demand-pull inflation cause by expansionary fiscal and monetary policy during COVID-19 pandemic; 

(3) supply-push inflation due to supply shocks (geopolitical war between Russia and Ukraine and zero-COVID-19 strategy of China), which caused supply-chain disruptions, surging energy and food prices and fewer workers are in the active labor market after pandemic; and 

(4) inflation expectations which people and firms expect higher prices in the future and they will translate this expectation into salary and contracts negotiations that lead to higher inflation. 

As central banks, such as the FED and the ECB, raised interest rate and executed QT program to combat inflation, we expect issues  (1), (2) and (3) are being addressed, in which rate hikes help reduce money supply; curb surging demand & consumption while waiting for supply side issued resolved soon. However, those actions won’t help ease (4) supply-push inflation and raising rates too much & too fast might also hurt growth rate or help push economies into a recession. According to Joseph Stiglitz, a nobel laureate professor from Columbia University, “raising interest rates is not going to solve the problem of inflation. It’s not going to create more food. It’s going to make it more difficult because you aren’t going be able to make the investments.”  So we think that central banks, especially the FED, must be very careful with their new aggressive rate hikes plan (FED is now expected to deliver a much steeper path of rate hikes than it had previously forecast in March which FED intent to lift FFR by total 1.75% in the next four sections of FOMC by the end of 2022). There should be a balance between subduing inflation & slowing down economy in order to avoid a “hard landing” for their economy. In addition, governments and policy makers, especially in US, should focus more effects to solve current supply shock issues (cause by geopolitical war between Russia and Ukraine and zero-COVID-19 strategy of China) by normalize supply-chain and reduce high energy & food prices, which raising interest rate can’t fixed.