75 basis points landed, the Fed cannot stop raising interest rates, and is not afraid of the side effects of economic recession

On September 21, local time, the Federal Reserve announced that it would continue to raise interest rates by 0.75 percentage points, raising the federal benchmark interest rate to between 3% and 3.25%, the highest level since early 2008. The decision was unanimously supported by the 12 members of the Federal Reserve's interest rate-setting committee, and hinted that further significant interest rate hikes may be made at future meetings to cope with the country's inflation approaching 40-year highs.

Jeffrey Gundlach, the "new bond king" and founder and CEO of DoubleLine Capital, commented that the Fed is pushing the economy into a recession. Powell also admitted at the press conference that a recession is possible and the chances of a "soft landing" are likely to decrease.

In the early 1980s, the Federal Reserve under Paul Volcker successfully "tamed" the double-digit inflation in the United States by continuously raising interest rates, but the price was an economic recession. Powell, who said last year that inflation was temporary, had to hurriedly copy Volcker's homework, and the recession script may be staged again.

Rate cuts may not come until 2024

Wednesday's dot chart and economic forecasts showed the Federal Reserve expects to raise its benchmark federal interest rate to 4.4% by the end of the year, meaning it will raise rates by at least 75 percentage points in the two remaining meetings this year.

The dot plot shows that six of nine officials support raising rates to a range of 4.75%-5% next year, but the central trend is 4.6%, which would put rates in a range of 4.5%-4.75%. The chart shows that rate cuts may wait until 2024, with officials predicting as many as three rate cuts in 2024 and four in 2025 to reduce the long-term benchmark rate to a median outlook of 2.9%.

The federal funds rate is the overnight rate at which banks borrow from one another, influencing other consumer and business borrowing costs across the economy, including rates on mortgages, credit cards, savings accounts, auto loans and corporate debt. Higher rates typically discourage spending, while lower rates encourage such borrowing.

Markets have been preparing for a more aggressive Fed.

“The Fed is not close to a pause or a turn,” Bill Zox, portfolio manager at Brandywine Global, said of the pace of rate hikes. “They are focused on hitting inflation, and a key question is what else they could disrupt.”

Traders have fully priced in a three-quarter percentage point rate hike, according to CME Group. Futures contracts ahead of Wednesday’s meeting implied a benchmark rate of 4.545% by April 2023.

As the Fed has been raising interest rates, it has been reducing its bond holdings that it has accumulated over the years. Starting in September, the pace of reduction further doubled to $95 billion per month, which also marked the beginning of the Fed's full-speed "quantitative tightening."

Recession for lower inflation

Inflation and recession are like two ends of a balancing beam. In theory, a sharp increase in interest rates will slow the economy. However, Fed officials are raising interest rates at the fastest pace since the 1980s and have approved rate hikes at five consecutive policy meetings.

The U.S. unemployment rate is expected to rise to 4.4% in 2023 from the current 3.7%, according to a summary of economic projections on Wednesday. Meanwhile, GDP growth is expected to slip to just 0.2% in 2022 before rising slightly to the long-term growth rate of 1.8% in the following years. The revised forecast is a sharp downgrade from the 1.7% forecast in June and comes after two consecutive quarters of negative growth, which is the consensus definition of a recession.

Powell acknowledged that a recession is possible, especially if the Fed has to continue tightening policy aggressively.

He said at the press conference: "No one knows whether this process will lead to a recession, or if so, how deep the recession will be... It will depend on how quickly wage and price inflation pressures fall, whether expectations remain stable and whether we get more labor supply."

"New Bond King" Gundlach said in an interview with CNBC that the inverted yield curve has shown that "the economy is flashing a red light."

The yield curve inverts when short-term Treasury yields exceed long-term Treasury yields. Many economists believe that the 2-year and 10-year parts of the yield curve are better predictors of potential recessions.

The 2-year/10-year U.S. Treasury yield curve first inverted on March 31, then returned to positive territory before briefly inverting again in June. This portion of the curve has remained inverted since early July.

After the Fed announced the rate hike, the policy-sensitive 2-year U.S. Treasury yield rose 15 basis points to 4.113%, the highest level since October 2007, and the benchmark 10-year Treasury yield hit a high of 3.64%, the highest level since February 2011.

“I do think unemployment is going to go up, we’re heading for a recession, and the Fed should be approaching this differently, but right now they’re so committed to this 2% [inflation target], I think the odds of a recession in 2023 are very high, I think 75%,” Gundlach explained.

“The aggressive signaling from the Fed did surprise us,” Mark Cabana, head of short rates at Bank of America, said in an interview with the Wall Street Journal. “It’s very consistent with the recent shift in commentary from the Fed, which sounds like the Fed is absolutely OK with risking a recession and getting inflation down through contractionary monetary policy.”

Not only the Fed, but central banks in other wealthy economies including Britain, Europe and Canada have also been raising interest rates at record rates, marking the fastest tightening of global monetary policy since 1989 , according to economists at Credit Suisse.