So far in 2022, the US Fed has hiked rates by 300 basis points with two more rate hikes scheduled in November and December. Market participants anticipate that the Fed will increase its benchmark rate by 0.75% in November and by 0.5% at its meeting in December 2022. Taken together, the Fed will most likely raise interest rates by another 1.25% before the end of the calendar year as a result of the persistent inflation data.
The US Fed observed in its most recent “Beige Book” that while the economy has grown somewhat, the conditions continue to vary by district. It also mentioned how the high-interest rate and inflation are making US businesses more pessimistic.
Fed is hiking rates to curtail demand following up with crushing new job openings. “Rising interest rates result in a demand slow-down, which translates to a fall in GDP growth rates,” says Ram Kalyan Medury, Founder and CEO of Jama Wealth, an investment advisory firm.
Medury explains how Fed has planned to pull down demand through rate hikes – Rate hikes increase the cost of funds for businesses, particularly businesses with debt, pulling down their net profits. Lower demand and higher cost of funds can result in companies going slow on spending. This can result in slow down of private investment. Corporations may also resort to layoffs as a cost-cutting measure. This can again impact demand for discretionary purchases.
As the cycle repeats, a slowdown in economic activity pulls down growth rates. In the calendar year 2022, the Fed has hiked interest rates by 300 bps (3%). As per Fed’s own estimates, GDP growth for 2022 is likely to be 0.2%. With more rate hikes, the next few quarters will be challenging for the US economy.