Fed hikes interest rates 75 basis points; now targets year-end funds rate of 4.4%

The Federal Reserve hiked interest rates by 75 basis points for the third consecutive meeting on Wednesday, boosting the target range for the federal funds rate to a range of 3% to 3.25%, in a continuing bid to tamp down inflation.

The Federal Open Market Committee, which concluded its two-day meeting on Wednesday, had previously increased rates by 75 basis points in June and July, following a 50-basis-point hike in May and a 25-basis-point increase in March.

In its accompanying statement, the Federal Open Market Committee said it "anticipates that ongoing increases in the target range will be appropriate."

The committee's median projection for the federal funds rate at the end of the year is now 4.4%, up from the 3.4% projection at the June meeting. The committee's median projection for the federal funds rate at the end of next year is now 4.6%, up from 3.8% projection in the June meeting.

The FOMC also cited "modest growth in spending and production" and that "job gains have been robust in recent months, and the unemployment rate has remained low." But the committee also said that inflation "remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures."

As it did at the prior meeting, the FOMC commented that the war in Ukraine is "causing tremendous human and economic hardship" and that war-related events are also "creating additional upward pressure on inflation and are weighing on global economic activity."

The committee added that it is "strongly committed" to returning inflation to its 2% objective.

Wednesday's rate hike, the fifth in as many meetings, was widely expected, based on the CME Group's FedWatch tool, which indicated earlier in the day that there was an 82% probability that the Fed would increase rates by 75 basis points at the meeting.

The decision to hike rates also followed a report from the U.S. Bureau of Labor Statistics on Sept. 13 that consumer prices jumped 8.3% from a year ago in August, compared with economists' expectations of an 8.1% rise, according to financial data firm FactSet Research Systems Inc. Consumer prices rose by 8.5% in July and surged by 9.1% year-over-year in June, the largest 12-month increase since the 12 months ended November 1981.

Fed Chairman Jerome H. Powell said at a news conference Wednesday that the Fed continues to see "risks to inflation as weighted to the upside."

He also said it might be appropriate to slow down the pace of rate hikes at some point.

Anders Persson, Charlotte-based CIO for global fixed income at Nuveen, said by email that the Fed "remains hawkish and committed to fighting inflation to the exclusion of any other goals, which argues for higher yields, flatter curves and wider credit spreads across fixed income markets."

The biggest surprise, Mr. Persson noted, came in the summary of economic projections. The median dot plot shows an expected fed funds rate of 4.4% at year-end and 4.6% at the end of 2023, higher than the market was pricing.

"Inflation is now expected to be even higher in the near term, with core (personal consumption expenditures) inflation expected to end the year at +4.5% and remain elevated at +3.1% next year," he added.

Seamus Smyth, New York-based chief economist at Virtus Investment Partners, said by email the rate decision "shows that they expect to continue hiking rates, and that there will be a bigger hit to growth, but they still see a relatively restrained increase in the unemployment rate — even if they are willing to run the risk of a recession, they aren't yet penciling it in."

Virtus has $155 billion in assets under management.

David Wagner, the Cincinnati-based portfolio manager at Aptus Capital Advisors, said by email that with respect to the impact on institutional investors, that the market has been driven by macro factors, specifically inflation expectations and Fed policy.

"Given the continued unknown of inflation and its effect on the overall demand aspect of the economy, we would assume that (institutional investors) would begin to think outside the box as to where returns can be derived from moving forward, given the potential for a new prolonged return environment," he said. "We believe that collared income strategies that have the ability to take advantage of single security implied volatility is a perfect example of a strategy that can provide yield and downside protection in an uncertain environment. We love the idea of differentiated liquid alternative investments."

Mr. Persson added that institutional bond investors are facing "fresh challenges" as fixed-income returns "will be adversely affected by this combination of higher rates and slower growth."

Andrzej Skiba, head of U.S. fixed income at RBC Global Asset Management, said in a client note: "We expected 75bp at the meeting today, followed by another 75bp in November from the Fed." He also said that at this stage, "we would not expect U.S. recession to be very deep, reflecting the strength of the consumer, solid labor market and strong corporate balance sheets. We're entering this slowdown in the best shape we had in a very long time."