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The U.S. CPI in January 2022 rose by 7.5% year-on-year, hitting a 40-year high, marking the second consecutive month that the U.S. consumer price index (CPI) exceeded 7%.
On March 17, the Federal Reserve announced to raise interest rates by 25 basis points (0.25%), raising the target range of the federal funds rate to 0.25%-0.5%. This is the first time the Fed has raised interest rates since 2018.
Not only that, but the Fed also revealed more aggressive measures, expected to raise interest rates at six policy meetings this year, to intensify efforts to slow inflation, which is at its highest level in 40 years. In addition, the process of shrinking the $9 trillion balance sheet will be announced in May.
The Russia-Ukraine conflict brings new variables for the Fed to control inflation – Russia is a major energy exporter and Ukraine is a major food exporter, both of which are critical to global inflation.
boots fall
Since the interest rate meeting in January this year, the Fed’s interest rate hike expectations have continued to disturb the U.S. stock market, with the S&P 500 falling about 10% from its high point. In February, the U.S. Department of Labor announced that the U.S. consumer price index (CPI) hit a 40-year high, and expectations for interest rate hikes began to rise.
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Fed Chair Powell
Before the aforementioned CPI data, few expected the Fed to raise rates by 0.5 percentage points in March, as the Fed had not raised rates by 50 basis points (or 0.5 percentage points) at a time since May 2000, and roughly since the 1980s , the Fed has never started a tightening cycle by raising interest rates by 50 basis points.
But after the CPI data was released, St. Louis Fed President James Bullard said he had become “clearly” more hawkish as inflation data hit the highest level in nearly 40 years, and he now hopes for the next three Fed policy decisions The meeting raised interest rates by one percentage point.
Reuters also said that the larger-than-expected jump in prices not only frustrated expectations of a slowdown in inflation, but also reinforced the view that the Fed is lagging behind the situation.
In the end, the boots landed, and the Fed chose to raise interest rates by 25 basis points. Although the rate was small, it was clear that more aggressive interest rate hikes and balance sheet reduction policies would be adopted in the future.
What exactly does the Fed mean by raising interest rates?
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Rising prices for oil and other commodities due to the Russia-Ukraine conflict have added additional pressure to short-term U.S. inflation.
Specifically, it means raising the federal funds rate, which in short is the rate at which U.S. banks and banks lend money to each other. After the 0.25% increase this time, the interest rate target range will be increased to 0.25%-0.5%.
If this rate rises, the rate at which banks lend to businesses or individuals will also rise, reducing the money supply and reducing inflation, thereby cooling the economy.
Conversely, if the interest rate is cut, the interest rate on bank lending will be lower, and the cost of borrowing money will be lower, which will stimulate business and personal lending, and generally speaking, the overall economy will be stimulated and become more active.
The Fed adjusts this rate to achieve one goal – to maintain maximum employment and price stability in the United States. Cut interest rates when the economy is weak to inject more liquidity into the market and stimulate the economy. Raising interest rates when the economy is strong reduces the money supply, lowers inflation, and prevents the economy from overheating.
The United States was hit hard by the 2008 financial crisis. In order to increase the money supply and boost the economy, the Federal Reserve once cut interest rates to 0-0.25%. This ultra-low interest rate was maintained for seven years. At the end of 2015, the Federal Reserve started a three-year interest rate hike channel, raising interest rates nine times in a row.
After the outbreak of the new crown epidemic, the Federal Reserve cut interest rates in an emergency in March 2020, dropping to 0-0.25% at one time, and interest rates returned to the zero interest rate era at the end of 2008, which has been maintained for four years until now.
inflationary pressure
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After a rate hike, higher borrowing rates help fight rising prices because it reduces demand for products like cars and homes — two of the biggest drivers of U.S. inflation, and this time around for how long and how much. It has far exceeded the initial expectations of Fed officials.
On February 10, data released by the U.S. Department of Labor showed that the unseasonably adjusted U.S. CPI in January 2022 rose by 7.5% year-on-year, hitting a 40-year high and the second consecutive U.S. consumer price index (CPI). Monthly exceeded 7%.
When inflation remains low (2-3%), economists call it the “lubricant” of the economy, because a small increase in prices can lift entrepreneurs’ incomes, spur them to invest further, and increase economic vitality.
Most economists also have a 2 percent inflation target, and a large deviation from this target for a long period of time is considered dangerous. Therefore, for the Fed, which plays the role of the central bank, how to control the high inflation has become a top priority.
Federal Reserve Chairman Jerome Powell reiterated this “immediate priority” in his post-rate hike speech, saying he prioritized U.S. inflation and said the U.S. labor market had reached an “unhealthy level” and wage growth needed to be moderated. slowing down inflation.
In his speech, Powell said U.S. inflation was already above the Fed’s long-term 2 percent target. Aggregate demand in the U.S. is very strong, with bottlenecks and supply constraints limiting how quickly production can resume. These supply-side disturbances have been longer and more intense than expected, and upward price pressures have spread widely across goods and services.
Powell also said that rising oil and other commodity prices caused by the Russia-Ukraine conflict added additional pressure to short-term U.S. inflation.
According to the U.S. Energy Information Administration, Russia is the world‘s third-largest oil producer after the United States and Saudi Arabia. In 2020, Russia extracted 10.5 million barrels of oil per day and exported 5 to 6 million barrels, half of which was exported to Europe.
North Sea Brent crude prices surged to near-record highs on March 7 after the United States and Europe proposed a possible ban on Russian oil imports. After rising 21% last week, it rose another 18% to nearly $140 a barrel before pulling back slightly.
Fuel and energy are the basic costs required to manufacture and transport goods, so rising oil prices not only push up the price of fuel, but everything else.
In addition, the war could also lead to higher food prices, as Russia and Ukraine are both major food producers. Russia and Ukraine produce 14 percent of global wheat and 29 percent of global exports, said Wandile Sihlobo, a senior fellow in agricultural economics at JPMorgan.
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A bundle of wheat as a Ukrainian Christmas decoration.
Combined, Barclays estimates that this could lead to a “stagflation” shock. They have cut their forecasts for global economic growth this year by 1 percentage point.
Stagflation refers to stagnant inflation, which is generally the simultaneous occurrence of economic stagnation, high inflation, and high unemployment. When an economy falls into stagflation, production declines, leading to rising unemployment and even a wave of bankruptcies.