The United States Federal Reserve raised interest rates to a 22-year high as it continued its fight against inflation. It is the highest level since 2001, and it also brings the target fed funds rate to a range of 5.25% to 5.50%.
The Fed's decision to raise rates has been met with mixed reactions. Some economists believe that the move is necessary to bring inflation under control, while others are concerned that it could lead to a recession.
The rate rises have sent mortgage rates sky-high. The average long-term US mortgage rate climbed to just under 7% lately. Rising rates are making it more difficult for people to obtain credit too. As reported by the New York Fed, the rejection rate for credit applicants increased to 21.8% in June, the highest level since June 2018, with would-be car buyers hit hardest.
The recent Fed rate hike is expected to have a negative impact on the stock market. Rising interest rates make it more expensive for businesses to borrow money and lead to lower corporate earnings, which would hurt stock prices. That is why most investors made decisions to return to a more neutral portfolio positioning.
The Fed’s measures to fight inflation
Fed raise rates is one of the elements of a large-scale campaign to curb inflation.
Representatives of the Federal Open Market Committee noted that they do not rule out the possibility of raising rates. But this is all to ensure that inflation, which is already receding, is thoroughly quashed.
The primary job of the Federal Reserve is to control inflation while avoiding a recession. The ideal inflation rate is around 2%, if it is higher than that, demand will drive up prices for goods and that is exactly when the Fed starts to use contractionary monetary policy to slow economic growth and control inflation.
Fed interest rate hike is not the only tool. Traditionally, the Fed has several methods to tame inflation.
Open Market Operations (OMO)
The Fed's main instrument is OMO. OMOs are the buying and selling of US Treasury securities by the Federal Reserve. When the FOMC wants to raise interest rates to combat inflation, it will sell Treasury securities. This will withdraw money from the economy and push up interest rates. When the FOMC wants to lower interest rates to stimulate economic growth, it will buy Treasury securities, thus injecting money into the economy and pushing down interest rates.
Fed Funds Rate (FFR)
The FFR is the interest rate that banks charge each other for overnight loans. The Fed can influence the FFR by buying and selling US Treasury securities in the open market. When the FFR rises, it becomes more expensive for businesses to borrow money, which slows economic growth.
The reserve requirement is the percentage of deposits that banks must hold in reserve at the Fed. The Fed can influence the reserve requirement by changing it. In particular, raising reserve requirements will help combat inflation.
The discount rate is the interest rate that the Fed charges banks for loans. Raising the discount rate helps the Fed to combat inflation. It will make it more expensive for banks to borrow money from the Fed, which consequently will make it more expensive for banks to lend money to businesses and consumers.
Managing Public Expectations
Former FED Chairman Ben Bernanke noted that public expectations of inflation influence its real rate. Once people anticipate future price increases, they create a self-fulfilling prophecy. They plan for future price increases by buying more now, thus driving up inflation even more.
Is this the last Fed rate hike?
There are doubts about it. Fed Chair Jerome Powell stays noncommittal about any expectations for the next Fed rate hike. He mentioned that it is both possible that the Fed will raise rates again at the next meeting or hold steady.
Since starting its inflation-controlling policies, the Fed has often telegraphed its upcoming action. So all we can do is hope and wait for September when another FOMC will take place.