Key Takeaways:
- Last week, the Federal Reserve raised the Federal Funds Rate by 0.25%.
The Federal Reserve is projecting several more rate increases in 2022.
The Federal Reserve is confident in a strong US economy and the ability for the economy to withstand higher interest rates.
Last week the Federal Reserve raised interest rates for the first time since 2018, commencing the beginning of the end of an ultra-easy monetary policy period. While the increase was small in magnitude – only 0.25% – it was large in relevance. Chairman Jerome Powell also indicated an expectation of future rate increases and a Federal Reserve balance sheet reduction.
An increase in the Federal Funds rate was needed. Few economists and pundits alike would argue that it was too early to be raising rates from an economic standpoint. The economy is strong, with annualized GDP projected at 2.8%, albeit down from the 4% previously estimated, largely due to the war in Russia/Ukraine and higher US gas prices. Additionally, annualized inflation is now hovering around 8%, reflecting one of the largest increases since the early 1980s. Current interest rates are also at the ground level, with zero ability to lower rates when we do need to spur economic growth.
While raising rates is a natural headwind to economic growth, it was applauded by the markets last week. Investors welcomed the Federal Reserve’s confidence, despite the unknown concerns arising from the Russia/Ukraine war. Said simply, if the Fed was overly concerned about continued economic growth, they would not have raised rates.
Raising and lowering rates is a lever that the Federal Reserve utilizes to accelerate or slow economic growth within the US economy. Their goal is to achieve full employment and low inflation while softening the peaks and valleys of the economic boom/bust cycle. Fed policymakers walk the tight rope carefully, as allowing rates to stay low for too long can cause just as much harm as having rates too high and smothering growth.
From a consumer’s perspective, increased rates can be positive or negative. Savers will be rewarded with higher bank deposit rates and higher yields on investments, such as bonds. Borrowers, however, may feel the opposite impacts, with variable rate loans increasing and new debt rates higher than previously experienced.
After years (a decade-plus!) of discussing the potential of increasing rates, the Federal Reserve now appears adamant on bringing the plan to fruition. In December, most Fed policymakers projected three quarter-point rate increases in 2022. With inflation worsening, two-thirds of those same policymakers are now projecting seven or more rate increases this year.
Now is a great time to review all variable debts, anticipated new debts, and rates for your cash savings. Staying abreast of the interest rate environment will be important as we navigate interest rate changes over the upcoming months.
