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For the first time in 18 months, the Federal Reserve decided to pause its aggressive rate hiking campaign and maintain the target range for the federal funds rate at 5 to 5.25%. The central bank began a restrictive monetary policy back in March 2022 and continued to raise its benchmark rate for 10 consecutive meetings. Real progress has been made on the Federal Reserve’s dual mandate of price stability and maximum employment; however, policymakers signaled more rate hikes may be necessary in its fight against inflation.

Even though the headline level of inflation remains well above the Fed’s 2% target, the annual rate of change has been falling steadily. The year-over-year Consumer Price Index (CPI) peaked at 9.1% in June 2022, and has declined sequentially over the past 11 months. The most recent CPI report, May 2023, showed inflation rose at a 4% annual rate, the lowest in 2 years.

Labor markets on the other hand remain extremely tight and inflationary. The most recent employment report showed solid growth as the U.S economy added 339,000 nonfarm payrolls in May. The 3.7% unemployment rate still hovers near 50-year lows.

The prudent decision to pause allows the central bank to assess incoming economic data and its implications for monetary policy. Although economic activity has continued to expand at a modest pace, policymakers have highlighted how much they’ve done so far and so quickly, as well as uncertain lags of monetary policy and overall tighter credit conditions as reasons to pause. The response lag, the time it takes for policy measures to work their way through the economy, is just now hitting. While the U.S. banking system is sound, the recent fallout from the regional banking sector acts much like additional rate hikes as households and businesses experience tighter credit conditions.

The next Federal Reserve meeting is scheduled for July 24 – 25. Markets are already anticipating a quarter-point interest rate hike, however additional rate increases are likely on hold and any decision from policymakers will be determined by incoming inflation, employment, and other important economic data.

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