What does the Fed rate hike mean for us?

Why raise rates?

The rate of inflation or price increase in the United States has been at a four-decade high. Retail inflation stood at 7.9% in February. The last time inflation was anywhere near this level was in January 1982, when it stood at 8.3%.

Much of this has been caused by supply disruptions, first due to the outbreak of the pandemic and then later by Russia’s invasion of Ukraine and raising the prices of oil, natural gas and other commodities.

As the Federal Reserve said in a statement: “Inflation remains high, reflecting supply and demand imbalances related to the pandemic, high energy prices and widespread price pressures. Russia’s invasion of Ukraine is causing tremendous human and economic hardship.” Is.”

Of course, there is no way for central banks to control inflation due to supply-side issues. Then why raise rates? People also react to inflation. They look at the recent high inflation and believe it is likely to continue. The median one-year inflation expectation in the United States in February was 6%. This is the highest since June 2013, the first month from which data is available. When future inflation expectations are so high, people start to include it in their wage demands, leading to higher wage inflation, and inflation settles.

This is something the Federal Reserve doesn’t want to happen and therefore, over the years it has tried to set interest rates with the aim of keeping inflation at 2%. And to do so, it needs to raise interest rates and rein in consumption or demand for goods and services, and hopes to reduce inflation in the process.

What else is expected?

With inflation at 7.9%, raising the interest rate by 25 basis points will not do much to control it. However, the Federal Reserve also needs to ensure that it does not shock the financial system and the economy by being too aggressive in raising rates. Data released by the Federal Reserve shows that the average federal funds rate is expected to be 1.9% in December 2022. Given that the Fed has six meetings left this year, this means that each of these six is ​​likely to raise interest rates. With these hikes, the Federal Reserve expects inflation to moderate to 2.6% by the end of the year. This seems a bit optimistic considering how high inflation is currently.

Also, the Federal Reserve expects inflation to touch its comfort zone of just 2% in 2024. The average inflation forecast for 2024 is 2.1%.

Why are the stock markets going up?

Stock prices all over the world have risen following the Federal Reserve’s decision to raise rates. At the time of writing this, India’s leading stock market index BSE Sensex was up over 1,000 points or nearly 1.8% from Wednesday’s close. This is happening mainly because the Federal Reserve has done no surprises. The market expected it to hike interest rates by 25 basis points and that’s what it did. Inflation is not good for stocks and the move to control it is being welcomed.

However, as the Fed continues to raise rates, the stock markets will come under pressure. With interest rates rising in the United States, money from other parts of the world is likely to run out and find its way to the US.

easy money era

There is one more point that needs to be made here. Since September 2008, when Lehman Brothers, the fourth largest investment bank on Wall Street, went bankrupt, the rich world’s central banks, led by the Federal Reserve, have printed a lot of money and pumped it into the financial system to hold interest. . Lower rates to encourage people and companies to borrow and spend.

In fact, this money printing increased dramatically from the beginning of 2020, when the Covid pandemic began to spread. An estimate by The Economist shows that the central banks of the rich world have printed around $12 trillion in the past two years. This money needs to be taken out of the system gradually.

The Federal Reserve said a decision to do so would be made at an upcoming meeting. When this happens and on condition that it continues, the era of easy money to which the world has become so accustomed will begin to end. This is when there will be a real jump in stock prices. Of course, they have already fallen slightly from their all-time highs achieved last year.