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Fed Signals Prolonged High Interest Rates Despite Economic Uncertainties

Published 22/09/2023, 14:46
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The US Federal Reserve (Fed) has signaled that it anticipates maintaining high-interest rates for an extended period, despite leaving them on hold for the time being. This decision, announced on Wednesday, was widely anticipated and follows recent figures indicating a cooling labor market in the world's largest economy.

The Fed's stance comes as it continues to navigate the economy towards a "soft landing," aiming to control inflation without triggering a recession. However, projections released along with its decision showed that the central bank expects one more hike this year and a slower rate fall next year than previously anticipated.

Federal Reserve Chair Jerome Powell stated that the process of reducing inflation to its 2 percent target still had a "long way to go." He added, "We want to see compelling evidence that we have reached the appropriate level."

Despite rising unemployment, the Fed has revised upward its GDP growth expectations due to robust consumer spending. Ian Shepherdson from Pantheon Macroeconomics described the rate decision as an "aggressive hold" but suggested that the inflation and unemployment numbers might not turn out as the Fed expects.

The market now expects one more hike before year-end and only a few cuts by the end of next year. This expectation has caused some panic among market participants, fearing a potential recession.

Higher interest rates have resulted in a significant decline in inflation, boosting the demand for money. However, there are concerns about emerging weaknesses in sectors such as housing, which has been impacted by soaring home prices, mortgage rates, and spreads over Treasuries. This has led to a decrease in new mortgage applications, weakening housing starts, and cooling builder sentiment.

Despite these uncertainties, high-dividend ETFs gained on Sep 20, despite the Fed’s signals of a prolonged higher rate environment. The Fed's approach may achieve its goal of taming inflation without causing a severe economic downturn, but officials have expressed caution about declaring victory too soon.

The Fed's decision to maintain high-interest rates and reduce its bond holdings has already reduced the central bank’s balance sheet by approximately $815 billion since June 2022. The Fed allows up to $95 billion in proceeds from maturing bonds to roll off each month without reinvesting them.

In conclusion, the Fed's stance of maintaining high interest rates for a prolonged period signals a cautious approach toward managing inflation and economic growth. This has implications for various sectors, including housing and investment avenues that can beat the benchmark U.S. treasury bond yields.

This article was generated with the support of AI and reviewed by an editor. For more information see our T&C.

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