The Federal Reserve is anticipated to approve its 11th interest rate increase since March 2022, despite an improving inflation situation. Markets are convinced that the Fed will implement a quarter percentage point hike, reaching a target range of 5.25%-5.5%, the highest level since January 2001. However, there is uncertainty about the Fed's future course, as policymakers are split on whether more rate hikes are necessary to combat inflation or if they risk pushing the economy into a recession.
Many investors hope that this will be the last rate hike for a while, as the annual inflation rate declined to 3% in June compared to 9.1% a year ago. Some believe that the Fed has already done enough to address inflation concerns and that further rate hikes could harm economic growth.
Despite the Fed's indications of potential future rate increases, traders in the market seem less concerned, pricing in only a 35% probability of another hike before the end of the year. The outcome of the meeting will depend on whether Fed Chairman Jerome Powell hints at the possibility of skipping a hike at the next meeting in September to assess the impact of previous increases on the economy.
Fed policy is influenced by the belief that it is better to do more than too little when fighting inflation, as history has shown the consequences of backing off the inflation fight too soon. The Fed faces a delicate balancing act, as not taking enough action could lead to stagflation, while being too aggressive risks causing a recession.
Recent indicators suggest that credit conditions are tightening, with higher interest rates and stricter lending standards posing challenges to future economic growth. While recent softer core inflation may be welcomed by Powell, he may want to see several more months of such data before confidently ending the hiking cycle.
Some economists argue that the economy is heading into a recession, and the Fed should be cautious about expressing confidence in a soft landing. The ongoing dynamics of an economy make recession avoidance crucial, as disinflation may be temporary, and the Fed's belief in the end of the hiking cycle might prove mistaken.
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