Mint explainer: Why the US Federal Reserve hasn’t raised rates

Why is the Fed raising interest rates?

The federal funds rate is the rate at which commercial banks in the US lend money held in the Federal Reserve System to each other on an overnight basis. In March 2022, the Fed began raising this rate. It is also slowly taking out the money it has printed and pumped into the financial system over the years. These steps help raise interest rates to discourage individual consumption and investment by firms. This ensures that there is less money chasing existing goods and services, and thus helps control inflation, which is the rate of increase in prices.

Is the Fed done with raising interest rates?

The Fed expects the federal funds rate to rise from 5.4% to 5.6% by the end of 2023. Hence, at least one hike is due given the current range of 5% to 5.25%. This has not been done with increases, mainly because inflation remains above the target level of 2%. In April, the core personal consumption expenditure (PCE) index – the Fed’s preferred inflation measure, which excludes food and fuel – rose to 4.7% in April 2022 against 5%. It is expected to fall to 3.9% by the end of 2023. So, inflation is slowly coming down, which explains why the Fed hasn’t raised rates yet.

Why not just keep raising rates and get on with it?

The housing sector is already feeling the impact of higher rates, with the median selling price of homes sold in the US falling from an all-time high of $479,500 during October-December to $436,800 during January-March. But it will take longer to get “broad demand and spending” under control. As Fed chair Jerome Powell said, “There is no certainty or agreement … how long it takes.” Hence the pause.

So, when will the Fed raise rates again?

The Fed has kept the option of raising rates open again. However, if inflation continues to fall, it may be very difficult to make a case for this. So the big question is when will the Fed start cutting rates? This question is also not easy to answer, given that the Fed expects core PCE inflation to be 2.6% in late 2024 and 2.2% in late 2025, well above its 2% target. Thus, we may see a status quo on rates for some time, unless the inflation data changes dramatically.

What does this mean for India?

In the aftermath of the Covid pandemic, the Federal Reserve cut interest rates to nearly 0%, leading to foreign portfolio investors buying a record $37 billion worth of stocks in 2020-21. Since then their purchases have slowed down. In addition, venture capitalists invested record amounts in startups, turning many of them into unicorns. VC money into startups has dried up since then, forcing many of them to lay off staff. Only a cut in interest rates in the US can change this situation.

Updated: June 15, 2023, 12:38 PM IST