U.S. Braces for Another Fed Rate Hike in May, Likely 50 Basis Points

In March, the U.S. Federal Reserve raised rates by 25 basis points, which was the first rate hike since 2018. The U.S. Central Bank raised rates despite the geopolitical turmoil amid the Russia-Ukraine war.

The FOMC is meeting on May 3–4. U.S. inflation hasn’t shown any signs of abating and rose further to 8.5 percent in April. Will the Fed raise rates in May again to tame inflation and by how much?

The Fed would announce its rate hike decision on May 4, which is the second and final day of the meeting. Fed Chair Jerome Powell is expected to announce a rate hike during the meeting. U.S. interest rates were zero-bound between December 2008 and December 2015. In December 2015, then-Fed Chair and current Treasury Secretary Janet Yellen began raising rates.

Powell continued the rate hikes despite pressure from then-President Donald Trump who saw rate hikes as running contrary to his growth agenda. However, as the U.S. economy showed signs of stagnation, Powell started cutting rates in 2019. In 2020, the U.S. Central Bank went on a record easing spree to support the U.S. economy amid the COVID-19 pandemic.

Powell has signaled in no uncertain terms that containing inflation is the top priority for the Fed. For most of 2021, the Fed maintained that inflation was “transitory.” However, as price rise started to appear stickier, it stopped using the term.

The CME FedWatch Tool puts a 99.8 percent probability that the Fed would raise rates by 50 basis points. Economists surveyed by Bloomberg expect Powell to raise rates by 50 basis points at its May meeting.

The respondents expect the Fed to raise rates by 50 basis points at the June meeting also. If this turns out to be the case, it would be the first time since 2000 that the Fed would raise by that quantum.

The consensus seems to be that the Fed will go for front-loading of rate hikes. After two 50 basis point rate hikes in May and June, the Fed is expected to revert to the usual 25 basis points rate hikes. By front-loading rate hikes, the Fed should be better able to manage the soaring inflation compared to the 25 basis rate hikes.

The Fed’s meeting is coming days after the GDP print for the first quarter of 2022 showed that the U.S. economy contracted by 1.4 percent annualized in the period. This is the first time since 2020 that U.S. quarterly GDP has fallen on a YoY basis.

The U.S. yield curve also recently inverted, which raised fears of a recession. U.S. economic growth was expected to come down and the Russia-Ukraine war has only added to the pessimism.

The Fed has a tough balancing task at hand. On the one hand, it has to tame inflation, which is running over four times what it's comfortable with. On the other hand, the Fed has to ensure that the rate hikes don’t have a massive impact on the economy.