The big question racing through the financial markets is how much more the Federal Reserve will raise interest rates.
Since the beginning of the rate hike campaign in March, the Fed has raised the Federal Funds rate by 375 basis points (3.75 percentage points) to a range of 3.75% to 4%. In September, Fed officials predicted interest rates will peak at around 4.6% next year.
But in November, Fed Chairman Jerome Powell said the Fed may have to go further than expected. And now experts, including interest rate traders, have united around a 5% forecast.
But James Bullard, president of the St. Louis Fed, said last week that the Fed may need to raise rates further.
Using the so-called Taylor rule for monetary policy, Bullard suggested that the federal funds rate may need to go beyond 5%, to as high as 7%.
Good for savings accounts, bad for loans
That’s good for you if you have a savings account or money market fund or want to buy single bonds. That’s because it would drive up interest rates on those assets. But it is bad if you are planning to take out a loan as you will have to pay back at higher interest rates.
As for the Taylor rule, it states that the federal funds rate should be guided by two factors: the difference between actual and target inflation and that between actual and target GDP growth.
The Fed has an inflation target of 2%. But the favorite inflation indicator, the personal consumer spending index, rose 6.2% in the 12 months through September.
“So far, the change in monetary policy appears to have had only limited effects on perceived inflation,” Bullard said. The September figure was unchanged from August and only slightly down from July’s 6.4%, although it was down more significantly from June’s 7%.
“To reach a sufficiently restrictive level, policy rates will have to be raised further,” he said.
Federal funds can reach 9%
Lindsey Piegza, chief economist at securities firm Stifel, says Federal Funds rates may need to be raised above 7%.
“While Bullard’s calculation seems reasonable on the lower bound, even at 7%, the upper bound may be an underestimation of the high interest rate needed given the potential for more aggressive assumptions,” she said.
Complicated calculations related to economic growth indicate “a potential need” for the federal funds rate to rise to 8% to 9%, Piegza said.
“The recent improvement in inflationary pressures transitioning from peak levels has seemingly… blinded many investors to the need for the Fed to continue aggressively on the path to higher rates,” she said.
The consumer price index’s 7.7% increase in the 12 months through October represents an improvement from the 8.2% increase through September, Piegza said.
But, “it’s hardly something to celebrate or a clear signal for the Fed to move to a simpler policy, with a target range of 2%. [for inflation] another distant achievement,” she said.
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