When Will US Tightening Monetary Policy Of The Fed Come To An End? – Analysis


By Wei Hongxu*

On May 3, the Federal Reserve announced a 25 basis point interest rate hike as expected, raising the federal funds rate target range to between 5% and 5.25% following the conclusion of its monetary policy meeting. This marks the 10th time the Fed raising interest rates since entering this round of tightening cycle in March 2022, with a cumulative increase of 500 basis points. Although the market had largely anticipated the current hike, there was no clear indication during the meeting as to when the Fed will stop raising rates or even when it might start cutting them. Fed Chair Jerome Powell stated that he still believes that inflation is too high and that it is too early to declare the end of the rate hike cycle. Wall Street had hoped that this would be the final rate hike of this tightening cycle, but Powell denied that possibility. Additionally, Powell said that it is too early to discuss rate cuts. The disparity between the Fed’s policy expectations and the market’s performance led to declines in all three major US stock indexes on that day, with the Dow falling 0.80%, the Nasdaq dropping 0.46%, and the S&P 500 falling 0.70%.

Powell acknowledged that the turning point of the rate hike cycle is drawing near, stating that “we’re closer, or maybe even there”. ANBOUND researchers believe that while the Fed’s policy interest rate peak has been essentially reached, its monetary policy may fall behind market expectations and require time for confirmation. The Fed is still in the process of reducing its balance sheet, indicating that the monetary tightening cycle is ongoing. As the tightening cycle draws to a close, factors such as U.S. inflation levels, economic growth, and the ongoing banking crisis plaguing the U.S. financial industry will be the main drivers of changes in the Fed’s policy cycle. The risks continue to accumulate to an unprecedented degree as the tightening policy approaches its end.

At this meeting, the Fed once again emphasized its determination to lower inflation to 2%. Given the current high level of U.S. inflation, it is expected that the Fed will find it difficult to change its policy quickly. However, what it can do is slow down the rate of interest rate hikes and adjust the pace of balance sheet reduction as it approaches the interest rate peak in order to mitigate the risks and harm caused by the excessive policy. ANBOUND had previously mentioned the 5% policy rate adjustment end value, which could be considered an extreme case. Currently, Powell also admits that the current interest rate level has reached the restrictive range. Regarding policy rates, most market institutions and Fed officials actually believe that the rate has reached its extreme value. Although inflation is still high at present and shows strong resilience, at least it has not continued to rise, but rather has remained high, indicating that inflation has been somewhat suppressed.

Hence, on the issue of the endpoint of interest rate hikes, there is not much difference between the current market and the Fed’s views. The main difference lies in how long to maintain the current level of interest rates, which largely depends on when inflation levels start to show a clear downward trend. Regarding the endpoint of the policy cycle, Powell emphasized that “there were a number of policymakers at today’s meeting talking about pausing, but not so much at this meeting”, and he added that ” “we can afford to look at the data and make a careful assessment”. Powell further pointed out that the full impact of monetary tightening will take time to manifest, and it may take several months of data to prove that the Fed’s policy is correct. This confirms from another perspective that the expectation of a quick interest rate cut by the Fed is too optimistic.

Another difference between the Fed and the market is their expectations for U.S. economic growth. Former U.S. Treasury Secretary Lawrence Summers and others have repeatedly warned that in the case of rapid interest rate hikes, the U.S. economy will fall into a recession. Powell, who had previously been hopeful of a “soft landing” for the U.S. economy, also showed some changes after the monetary policy meeting. He stated, “The case of avoiding a recession is, in my view, more likely than that of having a recession. But it’s not — it’s not that the case of having a recession is — I don’t rule that out, either. It’s possible that we will have what I hope would be a mild recession”. At present, with the continuously rising interest rates, the tightening of monetary policy has already begun to slow down U.S. economic growth. From the Fed’s perspective, even if the U.S. economy falls into a recession, its top priority is still to contain inflation. Without a path to a “soft landing,” it is more likely to endure a certain degree of recession to achieve the inflation target as soon as possible. Whether future monetary policy will shift or not depends more on the extent of the economic downturn. As demand declines, inflation will also decrease. Although Powell still has confidence in the U.S. economy, the timing of his decisions may lead to a “too late” and “over-adjustment” problem, bringing significant policy risks. Therefore, whether the economy will enter a recession may be the biggest divergence in monetary policy.

In the short term, the uncertainty of the spread of the U.S. banking crisis also affects the direction of the Fed’s policy. As pointed out by ANBOUND researchers, to some extent, the consecutive bank failures in some regions of the U.S. are the consequences of the Fed’s continuous rate hikes. While the monetary policy remains tight, the U.S. banking crisis will persist. Once the systemic risks spread, it may lead to a financial crisis, resulting in a credit contraction and affecting demand and prices. Therefore, the banking crisis, as an uncertain factor, has a huge impact on inflation and economic growth for the time being. Even if the Fed maintains interest rates at high levels, it is still possible to adjust the pace of balance sheet reduction or even re-expansion to help struggling banks out of their predicament. At the same time, in the event of increased risk, the possibility of the Fed cutting interest rates early cannot be ruled out. Currently, the banking crisis is accelerating the pace of the economic cycle evolution, which may push the monetary policy tightening to an early end.

Final analysis conclusion:

As the Fed’s rate hikes gradually slow down, and with the evolution of inflation, economic growth, and the banking crisis in the U.S., the continuous rate hikes by are coming to an end, and the process of monetary tightening is accelerating. However, this does not mean a reduction in systemic risks in the U.S., but rather that they will accumulate as policy risks increase. Consequently, economic stagnation and financial crises are likely to arise, causing an unprecedented impact on the global economy and financial markets

Wei Hongxu is a researcher at ANBOUND


Anbound Consulting (Anbound) is an independent Think Tank with the headquarter based in Beijing. Established in 1993, Anbound specializes in public policy research, and enjoys a professional reputation in the areas of strategic forecasting, policy solutions and risk analysis. Anbound's research findings are widely recognized and create a deep interest within public media, academics and experts who are also providing consulting service to the State Council of China.

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