Author: Slavica Grabovac
Publication date: 20.12.2023
The Federal Reserve (Fed) rate hike refers to an increase in the federal funds rate. This rate is known as the interest rate at which commercial banks lend and borrow their surplus reserves with each other on an overnight basis. Also, it is used as a tool to control inflation and stabilize the economy. Therefore, understanding the implications of a Fed rate hike is crucial for anyone looking to manage their money wisely.
Rising Fed Rates
The Fed has raised its interest rate 11 times between March 2022 and July. Rates have gone from 0% to the current benchmark target range of 5.25%-5.50%. This decision has pushed up borrowing costs on all kinds of loans.
In general, higher interest rates can lead to increased borrowing costs for consumers. This way, it makes loans more expensive for things like mortgages, auto loans, and credit cards. As a result, that can lead to a reduction in consumer spending.
What do Federal Funds affect?
Except the consumer spending, increasing the federal funds rate can also have impact on:
As borrowing costs rise, businesses may find it more expensive to finance investments and expansions. This can lead to a slowdown in business investment.
Mortgage rates are influenced by changes in the federal funds rate. When rates go up, it can lead to higher mortgage rates and make home purchases less affordable for buyers.
Rise in federal funds rate usually causes interest rates to rise across the broader economy, leading to a strengthening of the dollar. A strong dollar reduces the cost of foreign imports, products become cheaper in the US and inflation goes down.
All of these impacts can discourage spending and slow down the economy in order to decrease very high inflation. Low inflation is one of the main goals of the Fed.
What is the next move?
In 2011, the Fed officially adopted a 2% inflation rate as its target. Given recent reports indicating a decline in inflation, traders are expecting that the Federal Reserve will reduce its federal funds rate within the next few months.
Couple of days ago, Federal Reserve Chairman Jerome Powell rejected the speculations on decreasing Fed rates. He said that it is premature to claim triumph over inflation. Despite recent positive signals on pricing, Powell emphasized that the Federal Open Market Committee intends to maintain a "restrictive" policy. It will be held like this until there is a solid conviction among policymakers that inflation is consistently moving toward the 2% target.
Thomas Barkin, CEO of the Federal Reserve Bank of Richmond, said for CNBC that rate hikes are still a possibility if inflation doesn’t continue to fall. Overall, lower inflation over the next three to five months could convince the Fed to respond by cutting rates.