The Fed indicates that the battle against inflation will become more challenging beyond the initial hike.

• The Federal Reserve raised interest rates by 25 basis points on Wednesday, marking the first increase since 2018.
• According to Kathy Bostjancic, the outlook of Chair Jerome Powell and the Fed's projections for GDP, inflation, and future rate hikes provide insight into the future direction of the economy and the risk of recession in light of new risks from the war in Ukraine.
• The Fed has revised its inflation outlook and now predicts six additional rate hikes, with inflation exceeding 4%.

Since 2018, the Federal Reserve has raised its benchmark interest rate for the first time, but the market should now look beyond this anticipated move, as stated by Kathy Bostjancic, the chief U.S. economist at Oxford Economics.

Despite the ongoing conflict in Ukraine, the Fed's primary concern is the continued strength of economic growth. If the Fed hesitates to raise interest rates and reduce the balance sheet due to the war, it risks falling even further behind on inflation, according to Bostjancic. With consumers still holding onto high levels of savings and seeing wage increases, waiting too long to address inflation could lead to the Fed becoming more hawkish in the future.

The Fed predicted six additional rate hikes and significantly raised its inflation forecast, which is now above 4% for this year.

The Fed's actions can have significant consequences for the financial markets and the economy. If the Fed is too hawkish and tightens too quickly, it can cause a financial market convulsion and lead to a mass selling of risk assets, which can have a ripple effect on the real economy. Recent bond market activity, such as the narrowing of the spread between the two-year and 10-year treasuries, has stoked fears of an inverted yield curve, which is a signal that a recessionary scenario could occur.

Since the Fed announcement on Wednesday, yields have reached their highest levels since 2019.

Even though Bostjancic claims the Fed will not ignore these signals, recession is not the base case for her.

During recent testimony, Fed Chair Jerome Powell revealed that he expects inflation to run slightly faster than the Fed's previous forecast. Bostjancic stated that her view of the inflation outlook was much higher than the median forecast, closer to 4% than 3%. This has now been matched by the Fed. Her perspective is influenced by a strong labor market, resilient consumer, and the Fed being behind the curve on inflation.

The Fed must address inflation concerns as it is rapidly increasing, with a current rate close to 8%, which is significantly above the 3% target.

On Wednesday, the market had to process the "dot plot" and the Fed's economic projections for GDP and inflation, which caused the Dow to initially pare its gains. However, stocks ended higher with the Dow notching a gain of over 2%. The most significant factor is how Powell presents the Fed's thinking on Wednesday.

Bostjancic stated that by listening to how the Fed manages risks related to growth and inflation, we can gain insight into their reaction function and forward guidance.

Powell stated in his comments following the official announcement that the risk to inflation remains on the upward side, as he had previously stated after the last FOMC meeting. Despite Powell's assertion that he does not observe any indications of a wage-price spiral and that wage gains are already showing signs of moderating, the Fed anticipates that unemployment will end the year at 3.5%, according to its most recent forecast.

Food prices, which have double the weight of energy in the consumer price index, are not immune to war and are likely to rise even higher due to Russia's invasion of Ukraine, which impacts the production of wheat and other commodities, and will reverberate through the global supply chain.

Despite the outbreak of war, Powell has stated that rate hikes are imminent.

Oxford Economics agrees with the market view that the Fed will tighten by 175 basis points this year, but is uncertain if the hikes will remain limited to 25 basis points or include the possibility of a 50 basis point hike at some point. One FOMC member, James Bullard of the St. Louis Fed, voted for a 50 basis point hike at this meeting.

According to Bostjancic, the economy is robust and demand remains high, so even with the effects of war, growth is expected to be at least 3% this year. Therefore, the Fed should aim to reach a neutral rate as soon as possible without causing market instability.

The U.S. economy is not as severely affected by the war as Europe's, and the impact of the conflict on the U.S. economy is not as significant as it is on Europe's. Inflation in the U.S. is not likely to be significantly affected by the conflict in Ukraine.

The Fed has revised its GDP forecast for the year from 4% to 2.8%, citing the Ukraine war as a contributing factor. Additionally, the central bank expects higher inflation and anticipates implementing more rate hikes to address it.

The Fed chair, Powell, must express his viewpoint on the primary concern he has regarding the war's impact on the U.S. economy, inflation, and growth, as the market will closely monitor any signals he sends regarding the emphasis he places on risk analysis.

Bostjancic concludes that the Fed cannot control the war, despite the potential impact on supply chains and food and oil scarcity.

A central bank cannot predict the likelihood of a ceasefire in war.

The ECB has become more hawkish in its policy views, holding rates but indicating that it will wind down stimulus sooner rather than later, as it seeks to fight inflation even if growth is slowing. This aligns with an outlook on the Fed that suggests it can be more hawkish even in the face of larger uncertainty.

The war may delay the Fed's balance sheet runoff by a month or two, but it should not significantly change the course of normalization of both rates and the Fed's bond market holdings, according to her view.

Powell stated in his press conference that the Fed is planning to proceed with the balance sheet reduction plan and may maintain the May timeline. He highlighted "remarkable advancements" in the FOMC members' discussions and mentioned that the balance sheet unwinding could commence at the May meeting.

The framework will be familiar to those who remember our previous attempt, but it will be quicker and occur earlier in the process than before.

The Fed must raise interest rates significantly to curb inflationary pressures, as recent data has shown, according to Bostjancic.

Powell stated in his press conference following the rate hike announcement that the risk of recession is not significantly increased, as this week's CNBC Fed Survey put the risk at 1 in 3. Additionally, the economy is robust, and inflation will eventually decrease. The median inflation projection among FOMC members is 4.3% for the year, and the forecast through 2024 is "notably higher" than previous Fed projections, Powell noted.

Powell stated that although it might take longer than desired, he is confident that we will utilize our resources to reduce inflation.

"The market has already priced in an aggressive rate hike profile, and the Fed was not expecting the market to price in less than it already has. As a result, the market is already in tightening conditions without the Fed having to do it. It's doing the work for the Fed," she said.

The Fed matched that view on Wednesday.