Sound the alarms! The Federal Reserve has officially announced that they will raise interest rates by 75 basis points (or three-quarters of a percentage) for the third time this year. The Fed’s goal is to curb the high levels of inflation the US economy has been facing in recent months. The basis point hike means that the federal funds rate, which is the interest rate at which banks borrow and lend to each other, will increase; this in turn affects individual citizens who will now be faced with higher costs required to borrow money. For example, credit cards typically follow the lead of the federal funds rate, so we are likely to soon see credit card companies increase charges placed on consumers. This interest rate hike highlights the economic circle the Federal Reserve is a main player in: higher interest rates cause less money to be placed into investments. Less investing means companies face lower productivity, which leads to less future profit, which lowers the company’s stock price. Finally, fluctuations in stock prices affect the bond market, which we can then conclude is indirectly influenced by the Fed’s decisions.
This rate hike is by no means surprising – last month, the Federal Reserve found that the inflation rate from August 2021 to August 2022 was 8.3%, which is much higher than the Fed’s goal of around 2%. This difference indicated that the Fed needed to continue its aggressive actions against inflation, which likely won’t lighten up until Chairman Powell sees convincing evidence of a slowing inflation rate. The rate hike has already been priced into the market, as economists and investors have suspected a 75 bps increase. People who’ve been keeping up with the Fed’s recent decisions know that raising rates too high (i.e., 100 bps) could potentially bring about the threat of a recession, while not raising them high enough (i.e., 50 bps) could allow inflation to continue growing. The FOMC’s difficult task is to find an equilibrium between both ends of this spectrum in order to bring prices back to stable levels.
Unfortunately, the outlook is grim – the Fed will apparently “plan for the worst” going forward. They are likely to determine that more interest rate increases are necessary, as inflation is remaining persistent. That said, the FOMC does not want to keep raising interest rates forever; raising them now by three-quarters of a percentage will possibly allow them to make only a half-percentage increase at the next meeting in November. According to CNBC, interest rates increasing by around 1.25 percentage points before the year ends is within the range of possibility. Powell is determined to slow inflation, and if that means becoming aggressive with interest rate hikes, then so be it.
The inflation conundrum is partially due to the United States’ emergence out of the pandemic. One of the main reasons inflation has soared to its current level is because demand has heavily outweighed supply for the past few months, due partially to individuals who saved money over the pandemic now eager to spend. However, a weakened supply chain (again, due to the pandemic) hasn’t been enough to support them. The Fed’s plan, then, was to raise interest rates so individuals would have less money to spend, which would translate to lower demand. Cooling demand would give supply chains some time to recuperate and eventually raise their previously-lowered production levels, at which time the Fed would begin to lower interest rates, allowing demand to rise once again. After this final step, supply and demand would return to relatively stable levels.
But alas, not everything in life goes according to plan. Many supply chains have not healed since the pandemic, so productivity remains low while demand stays high. This heavily contributes to the FOMC’s challenge. Hopefully, with enough luck, persistence, and basis points, we’ll soon be able to see over the inflation mountain and walk peacefully with Powell to the other side.
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