US raises interest rates for the 6th time in 2022; understand risks to the economy

The Fed (Federal Reserve, the American central bank) this Wednesday (2) raised its interest rate for the sixth time in 2022, and this is the fourth increase in a row of 0.75 percentage point. Now, the reference rate in the United States is advancing to a level between 3.75% and 4% per year.

Jerome Powell, chairman of the Fed, told a news conference after the rate was released on Wednesday that “it will be appropriate to slow the rate of increase [dos juros]” soon, but highlighted that the heated job market and, mainly, the persistent high inflation forces the authority to “keep the restrictive policy [juros elevados] for a while,” he commented.

The rate of interest rate acceleration is the fastest in the country in more than four decades and, moreover, before June of this year, the last time the rate had risen by 0.75 point was in 1994.

This sequence of increases, considered very aggressive by the American standard, is due to the need to curb the highest inflation in the country in more than 40 years.

The US consumer price index is up 8.2% in the 12 months through September, after rising 8.3% in August and reaching a peak of 9.1% in June, which was the biggest increase in cost. of life since November 1981. These are levels much higher than the 2% target for the country’s annual inflation for 2022.

“We will stay the course until the work is done,” said Powell, reinforcing that the goal is to return to 2% inflation per year.

Making credit more expensive is the most impactful way adopted by the monetary authority to withdraw money from circulation.

This is normally the main measure adopted by central banks in an attempt to curb the inflation that is advancing in various parts of the world.

The acceleration of prices on a global scale began this year as a reflection of supply failures caused by the pandemic, a problem that worsened with the War in Ukraine.

In the United States, the committee responsible for monetary policy at the Fed, better known by the acronym Fomc, has been approving rate hikes by the central bank since March, when the indicator was practically zero.

There are fears, however, that the cost of this monetary tightening will be a serious slowdown in economic activity on a global scale.

Among the effects of a recession are the absence of business growth, a consistent increase in unemployment and an exaggerated fall in consumption.

Investors reacted badly to Powell’s statements and the US stock market ended the day with a strong fall.

The S&P 500 parameter indicator fell by 2.5%. In the segment focused on technology companies and more dependent on cheap credit to grow, represented by the Nasdaq index, the drop was 3.36%. There was also a 1.55% drop in the Dow Jones, which tracks 30 large companies listed in New York.

“They [integrantes do Fomc] have to think about calibrating [a alta dos juros]. You’re trying to cool an economy, not put it into a deep freeze,” criticized Diane Swonk, chief economist at KPMG, in an interview with The Wall Street Journal.

With no prospect of company growth, investors tend to abandon the stock markets to seek gains in fixed income. The safest of these is the American one, where Treasury bonds tend to be more attractive with higher interest rates.

The movement of dollars towards US fixed income also makes the currency scarce in other countries.

Since the beginning of the year, the dollar has become 17% more expensive in the average comparison with the main currencies, according to the DXY index. In the same period, the US stock market plunged 21%, according to the S&P 500.

For the next meeting of monetary policy makers, scheduled for December 13th and 14th, there is an expectation of a slight deceleration in the rate of interest rate hikes, said economist Étore Sanchez, from Ativa Investimento, after analyzing this Wednesday’s bulletin. of the Federal

Sanchez said the Fed’s strategy is very similar to that adopted by the Central Bank of Brazil. Both highlighted in their recent communiqués that the measures to raise interest rates produce effects with some delay in terms of the objective of curbing inflation and other potential impacts on the economy.

“The Fomc signals that the restriction speed [ao crédito] was intense and a slowdown of this pace may be prudent”, commented the economist, who expects that the next interest rate hike, the last of the year, will be 0.50 percentage point and, in February 2023, it will rise only 0.25 point .

How U.S. Fixed Income Gets Better as the Fed Rises

Even before the rise in the Fed’s benchmark interest rates, it is the expectation of an increase in this rate that affects the yields on US Treasury bonds. When the market expects the rate to rise, the yield increases and more investors decide to use their dollars to buy these assets.

To understand this, however, anyone unfamiliar with the interest rate market must first understand the math behind a phrase repeated over and over by experts: yields rise when bond prices fall.

When investors expect the central bank’s rate to rise, they sell derivative bonds at the country’s benchmark interest rates. They do so because the value of these securities, which is fixed in advance until the maturity date, tends to be less advantageous compared to the future Fed rate.

The buyer pays a price lower than the initial value of the bond. But this role will continue to offer the same yield initially contracted. The proportional yield therefore gets higher.

That is, if a bond worth $1,000 pays an investor $40 a year in return, the investor’s annual yield is 4%. But if it trades on the market for $900, the new owner of that bond will continue to receive $40 a year until maturity. In this case, however, that $40 represents a yield of almost 4.5% over the $900 price. The yield went up because the price went down.