Because the Fed raised interest rates

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Because the Fed raised interest rates

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Prices of groceries, diapers and rent are rising rapidly, and Federal Reserve officials have been cautiously watching this trend.

On Wednesday, they took their biggest step to counter it, raising the official interest rate by a quarter of a percentage point.

That small change carries an important signal: politicians have turned completely towards fighting inflation and will do whatever it takes to make sure that price gains don’t stay hot for the months and years to come.

The Fed is acting at a tense time for many consumers and investors. Here’s what happened and what it could mean for markets and the economy.

The Fed has raised the federal funds rate, a short-term borrowing cost for banks, in what officials have reported is the first of a steady series of moves. Fed policy changes manifest themselves through other types of interest rates: mortgages, auto loans, and credit cards. Some of the interest rates consumers pay to borrow money have already risen in anticipation of upcoming Fed adjustments.

Policy makers predicted that there would be six more rate hikes of a similar size this year.

Political changes come at a difficult time for central bankers: they are tasked with maintaining price stability and inflation is progressing at the fastest pace in the past four decades. While officials expect price gains to moderate this year, how quickly and what will happen are uncertain, especially as the war in Ukraine drives up fuel costs and new virus restrictions in China threaten to perpetuate the disruptions to the fuel economy. supply chain.

The Fed is also tasked with promoting maximum employment, but with hiring jobs faster and more open than available, the target appears to have been achieved, at least for now.

The idea behind the rate hike is simple: higher borrowing costs can slow inflation by tempering demand. When it costs more to borrow, fewer people can afford homes and cars, and fewer companies can afford to expand or buy new machinery. The shopping comes back (which we are already starting to see). With fewer activities going on, companies need fewer workers. Lower demand for labor results in slower wage growth, which further cools demand. Rates effectively higher for cold water on the economy.

The effects of higher rates may be visible in the markets. Higher interest rates eventually tend to lower stock prices, partly because it costs companies more to operate when money is expensive to borrow, and partly because Fed rate hikes have a history of recessions. which are terrible for actions. Higher borrowing costs also tend to weigh on the value of other assets, such as homes, as would-be buyers avoid the market.

The Fed is also preparing to reduce its bond holdings balance sheet, and many economists expect Fed officials to release a plan to that effect as soon as May. This could push long-term rates higher and is likely to further reduce the prices of stocks, bonds and homes.

You may be wondering why the Fed would want to slow the economy and hurt the stock market. The central bank wants a strong economy, but sustainability is the name of the game: a little pain today could mean less pain tomorrow.

The Fed is trying to bring inflation to a level where rising prices don’t affect people’s spending choices or daily lives. Officials hope that if they can slow the economy enough to reduce inflation, without damaging it so much that it plunges it into a recession, they can set the stage for a long and steady expansion.

“I think it’s more likely that we can’t get what we call a soft landing,” Mr. Powell said during a recent testimony before lawmakers.

The Fed has disappointed the economy easily earlier: in the early 1990s it raised rates without increasing unemployment and appeared to be on the verge of reaching a soft landing before the pandemic hit, having raised rates between 2015 and 2018.

But economists have warned that this time around could be a difficult act to accomplish.

“I wouldn’t rule it out,” said Donald Kohn, former Fed Vice President, of a soft landing. But he said a repression of demand that has pushed unemployment higher is also possible.

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