Today, the Federal Reserve announced that it was raising the “Fed Funds Rate”, which is the intra-bank lending rate that banks charge one another. The increase was made after one of the eight yearly Federal Open Market Committee Meetings, which are generally attended by all seven members of the Federal Reserve Board, as well as the twelve regional Federal Reserve Bank Presidents, from around the country. While still low on a historical basis, the rate has risen by just 0.25%, to a range of 1.00-to-1.25%.
At the two-day meeting, the FOMC reviews many economic statistics, from each of the 12 regions, with an emphasis on Employment and Inflation in each. Following the meeting, Fed Chairwoman Janet Yellen announced that the labor market continues to improve, and that inflation is expected to soon approach the Fed’s two percent target rate.
Donald Trump has been trying to prod Ms. Yellen not to raise rates again, and several journalists have been reporting that some homeowners have had trouble with the last increase mortgage payment increase. Many retirees, however, have been clamoring for higher CD rates, since they need the higher income to live on. Although the Fed doesn’t set mortgage, consumer loan or CD rates, any adjustments to the “Funds Rate” generally do have some impact, across the interest rate spectrum!
Over the past 40 years that I have been involved specifically in the bond market, interest rates had never been anywhere near as low as they are now; that is, until ten years ago! To an extent, such very low rates had added to The Great Recession (4Q07 to 1Q09), since banks found ways to encourage mortgage re-financing and consumer lending to people who should not have qualified for the loans. Then, once the money was spent—on real estate and merchandise that they couldn’t afford—all they had left were big, big bills!
But, let’s consider today’s rate hike in terms of the Fed’s Dual Mandate—Maximum Employment and Stables Prices, along with Moderate Long-Term Interest Rates. The amount of necessary monetary stimulus dwindles as the labor market recovers, and if the rates remain depressed for too long, that could cause the economy to overheat, and inflation to overshoot the two percent target.
When rates are still extremely low, as they currently are, the Fed also has little ammunition to respond to another banking crisis, or a foreign currency crisis, such as occurred during the 1990s, both in Latin America and East Asia. This is why today’s rate increases makes perfect sense, as is the anticipated one more this year.
As always, the Fed doesn’t act on a rigid schedule regarding changes in monetary policy. Rather, it is constantly reviewing the updated data, keeping in constant touch with other central banks and considering its options. Ultimately, the Federal Reserve makes decisions on a meeting-to-meeting basis; however, it can act sooner, when necessary!