Fed may hike rates 50 bp in next 2 meetings to reach 2% sooner: Expert

'This will not be last aggressive hike by central bank, as it is behind the curve on inflation,' says economist at Moody's Analytics.

Fed may hike rates 50 bp in next 2 meetings to reach 2% sooner: Expert

The US Federal Reserve may hike rates by 50 basis points in each of its next two meetings to raise interest rates to 2% sooner, according to Ryan Sweet, an economist at Moody's Analytics.

"The effective fed funds rate is now forecast to average 2.1% in the fourth quarter, compared with 0.9% in the March baseline," Sweet told Anadolu Agency via email.

"The terminal fed funds rate, or where rates peak this cycle, is now 2.75%, 30 basis points higher than in the March baseline and will be hit nearly a year earlier than in the March baseline," he explained.

The Fed made a 50 basis points rate hike on Wednesday, its steepest since 2000, which carried the target range for the federal funds rate to a range of 0.75% to 1%.

If it increases interest rates by 50 basis points at the conclusion of its next two meetings, on June 15 and July 27, this would take the funds rate to a range of 1.75% to 2%.

The markets, however, were pricing in a 75-basis-point rate hike with an 87% probability for the June 15 meeting as of Friday, according to the FedWatch Tool provided by the US-based global markets company Chicago Mercantile Exchange Group.

The high probability was stemming from worries the Fed's monetary tightening could cause a slowdown, and even a recession, in the American economy. Such worries were evident on Thursday when there was a major selloff in US stock exchanges.

Sweet, on the other hand, said that the Fed was not the primary cause of the economic downturn in each of its past three monetary tightening cycles.

"Correlation does not mean causation. Just because a recession followed a Fed tightening cycle does not mean that the central bank was the primary cause of the downturn," he said.

'Fed is behind the curve on inflation'

The Fed Chair Jerome Powell said Wednesday during his post-meeting press conference that the US economy could handle the central bank's monetary tightening.

"He acknowledged that inflation is hurting consumers and that the inflation 'buck stops with him.' He said the Fed can hike rates and avoid a recession ... Unless the economy takes a turn for the worse or financial market conditions tighten significantly further, this may need to be our baseline assumption," Sweet explained.

The expert stressed that Fed policymakers are "highly attentive" to inflation risks, which explains their hawkish stance.

He listed COVID-19 lockdowns in China, Russia's war on Ukraine, and its impact on energy and food prices in addition to a tight US labor market as inflation risks.

Annual consumer inflation, or CPI, in the US rose 8.5% in March, marking the largest 12-month increase since December 1981, according to the Department of Labor. The CPI data for April will be released next Wednesday.

"This will not be the last aggressive hike by the central bank, as it is behind the curve on inflation," Sweet said.

Reducing balance sheet

About the Fed starting to reduce the size of its balance sheet, the analyst said: "The Fed has a ton of Treasury securities maturing over the next several months, giving the opportunity to be more aggressive on the reduction in its balance."

The Fed will begin reducing its massive $9 trillion balance sheet, which includes holdings of Treasury securities, debt, and mortgage-backed securities, at the beginning of June.

The central bank will roll off $30 billion of Treasury securities and $17.5 billion of mortgage-backed securities from June 1 onwards.

"The initial pace is $47.5 billion per month, but after three months it will increase to $95 billion. There is not a gradual increase, but there will be a sudden increase in September," Sweet explained.

"If the Fed sticks with its current plan, its balance sheet will decline by about $520 billion this year. This may sound like a lot, but the balance sheet will still be massive, around 37% of nominal GDP. It was less than 20% of nominal GDP before the pandemic," he concluded.