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July 2022

No More Mister Nice Guy

Key Points

• The Fed’s primary focus is bringing down inflation

• The Fed will be increasing interest rates at a brisk pace to slow the economy

• The Fed’s actions may cause the unemployment rate to increase

The Fed has accelerated its timetable for removing monetary stimulus. The Central Bank has updated its quarterly year-end federal funds rate projection to 3.4%. Back in March, their year-end projection was 1.9%.

This planned move will put the federal funds rate above the neutral rate of 2.375%, indicating that the rate will be in economically restrictive territory. This will mark the first time the funds rate has moved into this territory since the Fed started calculating the neutral rate back in 2012 (chart 1).


The Fed is growing concerned that inflation is becoming increasingly entrenched in Americans’ lifestyle, and is ramping up actions to combat it. The catalyst for the Fed’s more hawkish stance was the June Consumer Price Index (CPI) report, which was released on July 13. The CPI rate jumped to 9.1% year over year, its biggest increase since 1981, showing that price pressures remain broad-based. This has caused Fed Chair Jerome Powell to shift his stance. He has admitted that the Fed’s painless goal of a soft landing for the economy may not be achieved. He also stated that the unemployment rate could increase, and that the economy’s risk of entering a recession “is certainly a possibility.”

We are already starting to see that the Fed’s monetary policy actions are beginning to impact the financial markets. For example, the Fed is raising short-term interest rates and reducing the size of its bond portfolio, which should put upward pressure on longer-term interest rates. As a result of Fed actions so far, financial conditions have recently tightened: There is a bear market for the S&P 500, credit spreads have widened and the dollar has strengthened. The Goldman Sachs Financial Conditions Index, which is considered one of the best measurements of overall financial conditions, has moved above its long-term average (chart 2). The Fed now expects US economic growth of 1.7% this year on an annualized basis (versus 2.8% previously) and 1.7% in 2023 (versus 2.2%).

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