[Opinion] US Interest Rate Hike Policy Scenarios

Professor Jeong Yushin

The U.S. Federal Reserve's (Fed) interest rate policy is turning hawkish. According to an analysis of the minutes from the March Federal Open Market Committee (FOMC) meeting by Fed experts, all 16 FOMC members believe stronger rate hikes are needed compared to December last year. In December, opinions suggested at least one and up to four rate hikes this year, but in March, the minimum rose to five and the maximum to as many as twelve. The most hawkish rate hike proposal in December was to raise the benchmark rate to 1.125% this year, which is even lower than the mildest March proposal of 1.375%. This indicates a hawkish mood within this year’s FOMC.

At the press conference following the March FOMC, Fed Chair Jerome Powell hinted that rates would be raised at all five remaining FOMC meetings this year. Neel Kashkari, President of the Minneapolis Federal Reserve Bank, who had been considered a moderate dove, also declared a shift to a more aggressive rate hike stance. The most hawkish James Bullard, President of the St. Louis Fed, argues that to properly demonstrate the Fed’s commitment to curbing inflation, the benchmark rate should be raised above 3% within this year.

Why has the Fed become so aggressive about raising rates? Two main reasons can be identified. First, the economy is continuing to perform well, making now the right time to raise rates. Growth and employment indicators are expected to remain strong through 2024, reducing the relative burden. Second, the inflation risk is much greater than initially anticipated. Two factors caused this deviation from expectations. One is an external factor: Russia’s invasion of Ukraine has added further price pressures on supply chains. The other is a domestic factor: large-scale fiscal spending released as COVID-19 measures has excessively stimulated wage and housing rent increases. The problem is that these factors are not short-lived, meaning inflationary pressures will persist for quite some time. In particular, wages rose 4.5% year-over-year in Q4 last year, and the housing price index surged 19.2% year-over-year in January this year, supporting the Fed’s aggressive rate hike policy to curb inflation.

What are the prospects for future Fed rate hikes? Considering the recent mood, the most likely scenario is a 0.5 percentage point hike in May, followed by five hikes of 0.25 percentage points each. According to this scenario, the expected benchmark rate by the end of this year would be 2.0?2.25%, still below the Fed’s so-called ‘neutral rate’ of 2.375%, which neither stimulates nor restrains growth. This means the Fed faces little burden in raising rates to reduce inflationary pressures. This is why rate hikes are also expected next year. It is anticipated that rates will likely be raised three times in the first half of next year. In that case, the benchmark rate would rise to 2.75?3.0%, exceeding the neutral rate and triggering a growth-suppressing effect. Therefore, the Fed is expected to shift to a wait-and-see stance afterward. Fortunately, if core inflation declines as the Fed expects after the end of 2024, rate cuts to prevent economic slowdown could be possible starting in 2025.

The Fed’s rate hikes mark a critical point that could shake global financial markets and the broader real economy. Careful scenario analysis and preparation of countermeasures are necessary to avoid policy missteps.

Jung Yoo-shin, Dean of the Graduate School of Technology Management, Sogang University

This content was produced with the assistance of AI translation services.