Portugal Colonial - Markets on edge as Fed prepares renewed salvo against inflation

The central bank's policy setting Federal Open Market Committee (FOMC) wraps up its two-day meeting on Wednesday and is expected to announce a half-percentage point rate hike, taking the key borrowing rate above 0.75 percent after sitting at zero from the start of the pandemic through 2021, even as inflation picked up speed.

The expected hike is part of what the Fed has billed as a tightening cycle likely to continue throughout this year and into 2023, with the goal of taking the steam out an inflation wave that has pushed consumer prices to the highest levels in four decades.

The US central bank hiked rates by a quarter percentage point in March, the first increase since 2018, but top officials including Fed Chair Jerome Powell have said officials will move quickly and front-load the increases.

While Wall Street sentiment has showed signs of improving this week, the central bank's hawkish posture played a role in the equity bloodletting seen in recent weeks.

April was the worst month for the S&P 500 since the pandemic, while the Nasdaq's tech stocks, which are particularly sensitive to higher interest rates, suffered their biggest loss since October 2008.

The Fed's goal is to engineer a "soft landing," reining in inflation but avoiding a contraction in economic activity.

But with China's pandemic lockdowns worsening global supply snarls and the war in Ukraine pushing commodity prices higher, analysts fear factors beyond the central bank's control could undermine that goal, and perhaps plunge the world's largest economy into a recession.

"We don't know if a recession will be realized; it will depend critically upon what the Fed does and how quickly the Ukrainian situation is resolved," Robert Eisenbeis of Cumberland Advisors said in a note.

He warned, "Near-term probabilities are not favorable and suggest caution."

- Many shocks -

Interest rate hikes are aimed at dampening demand, to take the steam out of consumer prices that jumped 8.5 percent over the 12 months to March, the biggest annual jump since December 1981, caused in part by consumers spending more for scarce goods.

Fed officials have signaled they view the economy as healthy enough to withstand higher rates, since unemployment has retreated almost to where it was before the pandemic, and recent data has shown strong consumer and business spending, even though the economy fell in the first quarter.

However, in addition to the external factors, central bankers cannot engineer a solution for the worker shortages that have challenged businesses and raised fears of a wage-price spiral, when employees demand higher salaries and fuel price increases.

Powell, who will speak following the FOMC meeting -- the announcement is scheduled for 1800 GMT -- and could provide more insight on the Fed's thinking.

The policy committee also is expected to provide details on the plans for shedding its massive holdings of bonds built up during the pandemic, a strategy to keep credit flowing through the economy.

That also could unsettle financial markets and act as a brake on activity.

Kathy Bostjancic of Oxford Economics said that for the moment, signals point to "relatively low but rising odds of a recession in the next 12 months" but she warned the chances will increase if the factors driving inflation worsen.

P.Sousa--PC