Federal Reserve Lifts Rates by Quarter Point

On Wednesday, the Federal Reserve raised its key interest rate by a quarter point; this marks their ninth increase in a year.

The Fed is working to control high inflation while mitigating the potential risks of a banking crisis, including the recent collapse of Silicon Valley Bank which has alarmed investors.

Inflation

One of the primary objectives of the Federal Reserve is to keep inflation at or below 2 percent annually. This helps keep prices stable so people can afford what they need and want. Conversely, inflation can become dangerous when it rises too rapidly and causes economic growth to stall or even slow down.

The Fed often raises interest rates to slow the economy and bring prices back down to a more reasonable level. This works by making borrowing more costly for consumers, businesses, and investors; consequently, they tend to spend less money and reduce their demand for products, thus decreasing inflation.

History shows the Federal Reserve can cause economic growth to stall or even decline when companies cut costs or cease hiring altogether, leaving people out of work and driving unemployment up dramatically. This phenomenon, known as stagflation, has long been a concern for economists and policymakers.

To combat stagflation, the Fed has raised interest rates over four years, driving borrowing costs for borrowers everywhere higher than they've been in decades. This has resulted in higher consumer borrowing costs across various sectors such as credit card rates and auto loans.

Although inflation has been declining since last summer, it remains high. This factor plays a significant role in determining whether or not the Fed will continue to raise interest rates.

Inflation has a variety of effects on the economy, such as decreasing people's purchasing power and raising prices for staple items like food or medical bills. It also has an impact on economic growth and stock market values.

The Federal Reserve employs various data points to monitor inflation. These include the Consumer Price Index (CPI) and more specific price indices, such as the Wholesale Price Index (WPI).

As inflation has improved, some analysts anticipate the Fed to be more patient when it comes to future rate increases. On the other hand, others point out the recent collapse of SVB bank as evidence that they may be willing to take even bigger measures in order to combat price pressures they are currently facing.

Economic Growth

The Fed sets monetary policy to stimulate economic growth and maintain a healthy economy. It has two complementary goals that Congress has granted it: maximum employment opportunities and stable prices--in other words, low inflation.

The economy grows when individuals, businesses and government spend more money than they make. This leads to additional employment opportunities and higher incomes for all, thus increasing the economy's growth rate.

Economic growth in the United States is driven by a variety of factors, such as natural resources, labor force expansion, capital equipment and entrepreneurship. Furthermore, policies determine which direction economic growth takes.

For instance, effective tax and regulatory policies can encourage labor force growth by providing greater access to education, health care and training. They may also spur investment by creating more opportunities for entrepreneurship and innovation.

But growth can slow if the labor force shrinks or productivity drops. That means the economy requires more workers overall to produce the same amount of output, meaning each worker must do more work in order to sustain economic output at its current level.

Similarly, inflation can rise when demand for goods and services is weak. If prices remain high for an extended period, it could lead to unemployment or wage pressures.

That is why the Fed has sought to reduce inflation by raising interest rates. It has increased rates by a total of 1.5 percentage points this year and plans on doing so again in December 2021.

In the meantime, it has purchased $80 billion of short-term Treasuries and $40 billion of mortgage-backed securities each month to stimulate the economy and reduce prices. However, it has stated that these purchases will be reduced once there has been more progress made toward its objectives of maximum employment and price stability.

Though the Fed has made great strides toward returning inflation to its target level, it won't reach this mark without improving labor markets. To do this, a series of events must occur that cause unemployment to rise, slow wage growth and create job openings.

Financial Markets

Financial markets are the marketplaces where traders purchase and sell all manner of financial instruments, such as bonds, equities and foreign currencies. They enable businesses to raise capital, transfer risk and promote trade while giving consumers access to a wide variety of services and products.

When the Fed decides to raise interest rates, they have an immediate effect on the Federal Funds Rate - which is the short-term interest rate banks charge each other for overnight borrowing. But this rate is just one of several interest rates people and businesses pay on mortgages, credit cards and other consumer debt obligations.

As the Fed attempts to combat inflation, its rate hikes create a ripple effect throughout all aspects of the economy. For instance, if mortgages become more costly, housing demand could weaken and the economy could suffer as well. Conversely, auto loans or corporate bonds could become more expensive as supply of those loans tightens and the economy may experience slowdown.

With the onset of multiple banking crises, however, the Fed has been faced with a difficult choice: balance its commitment to combatting price pressures against its responsibility to safeguard the financial system. It also needs to assess how its own actions will influence both banks and the broader economy.

On Wednesday, the US central bank raised its key interest rate by a quarter percentage point - the eighth in a series of increases designed to keep inflation in check. Voting unanimously, FOMC members increased the benchmark overnight interest rate from 4.75%-5.00%, its highest level since 2007.

Following its decision, the Fed noted that it had seen "some progress toward the goals" of its monetary policy but still believed that continuing increases in the target range were necessary to prevent inflation from exceeding 2%.

Though inflation appears to be slowing, economists and investors were hoping the Fed would halt its rate-tightening cycle soon. Unfortunately, Powell's news conference provided no such indication, with stock and bond prices surging after his remarks.

The Fed’s Decision

On Wednesday, the Federal Reserve raised its benchmark rate by a quarter point as part of its yearlong effort to combat high inflation. This marks their ninth rate increase since 2007 to combat persistent price growth.

The Fed's decision to raise the Federal funds rate by a quarter percentage point, from 4.75% to 5%, underscores its determination to combat high inflation even if it adds additional financial strain on banks. Furthermore, they pointed out recent turmoil in the banking sector which they said has created tighter credit conditions for households and businesses which could negatively affect economic activity, hiring practices, and inflation expectations.

Despite the turmoil in the financial sector, the economy is still expanding. According to latest data, real GDP expanded at a solid pace in February - though slower than economists had anticipated. Furthermore, unemployment rose to 4.6% last month, but remains far below its average level over four decades.

Inflation, which has been a key focus of Fed efforts to combat high prices, remained flat in February. The core personal consumption expenditures price index stayed just above 6% year-over-year in February; slightly lower than January's 6.4% but well below its summer high of 9%.

Overall, the Fed's latest forecasts indicate inflation will remain high and they must continue to raise rates at least once more in the near future. However, they also expect the economy to expand less than projected this year and unemployment rates to reach historic lows by 2024.

That suggests the economy will remain strong for some time to come, but it also raises the question of how long the Fed needs to keep rates higher in order to contain high inflation. That decision is critical for investors since the faster an economy grows, the faster prices will rise.

The Fed's monetary policy committee has now raised its benchmark interest rate nine times this year, raising it from its December projection of 5.25% to 5.1% this year - slightly below that figure.