Federal Reserve Prepares for Interest Rate Hike
As supply chain stability continues to waver through the pandemic, the Federal Reserve (Fed) intends to raise interest rates next month to control consumer prices. By controlling consumer prices, the Fed limits money available to spend by increasing prices of loans and allows the supply chain time to recover.
The Federal Reserve functions as the central bank of the United States and aims to stabilize the economy by promoting full employment and reasonable consumer prices. The Fed has influenced interest rates and managed financial risks since its establishment in 1913, but March would mark the second time it would raise interest rates from near zero to combat consumer prices.
Raising interest rates could affect consumer spending since borrowing money will cost more, making consumers less likely to make large purchases on cars and homes. Fewer large purchases could allow the supply chain to correct itself and grow again, especially given current high prices due to shortages.
"I would say that the committee is of a mind to raise the federal funds rate at the March meeting, assuming that the conditions are appropriate for doing so," said Jerome H. Powell, Chair of the Federal Reserve at the Fed meeting last month.
During the pandemic, the supply chain suffered as workers stayed home to prevent the spread of COVID-19. The shortage of goods available paired with limited international trade limited where consumers could spend their money. As a result, businesses with products still available to consumers began facing increasing demands, and prices for goods continued to increase. For example, in 2020, the price of hand sanitizer increased 53%, while other supply chain items, including metals for manufacturing, continue to face growing shipping costs.
The unemployment rate has declined in recent months as people return to work. The current unemployment rate hovers at 3.9%, a significant decline from 14.7% in April 2020.
"Progress on vaccinations and an easing of supply constraints are expected to support continued gains in economic activity and employment as well as a reduction in inflation," said the Fed in a statement last month.
While interest rate adjustments seek to affect consumer prices, Dana Peterson, chief economist at the nonpartisan think-tank Conference Board, said people should not expect higher interest rates to reduce consumer prices immediately.
Instead, Peterson said the interest rate increase is "constructive towards addressing these inflationary pressures" as inflation currently rests at a 40-year record high. While the increase in rates will contribute to fixing consumer prices, they may not return to pre-pandemic levels until importing speeds return to normal. Since interest rates only apply to American banks, they do not affect importation costs.
As the Fed signals the first interest rate hike of the year, it risks affecting a stock market already hit by the pandemic and tensions between Russia and Ukraine as Russia shows signs of a potential invasion with the possible intention of annexing Ukraine.
"What they will have to do is say we will respond as conditions warrant," said Diane Swonk, chief economist at Grant Thornton. "We have inflation to deal with, and even with what we're seeing, financial conditions are too loose. That's the only message they can give at this time."
Narayana Kocherlakota, a former regional Fed bank president, pointed out the Fed's difficulties prioritizing lower consumer prices without crashing the economy under current pandemic pressures.
"This Fed is just in a completely different position now," said Narayana. "They're going to be more proactive… This is a very difficult moment."
The uncertainty behind the extent and number of interest rate adjustments the Fed will implement this year has left stockholders attempting to make predictions to increase earnings.
"Until the market and the Fed stop leapfrogging each other in terms of interest rate expectations, the market will stay volatile," said Jim Reid, a Deutsche Bank research strategist, in an email to clients. "With such an extreme month, today's month-end might see some position squaring, so maybe there'll be another late swing/surge/slump in the last 90 minutes."
As the stock market shifts and the Fed prepares to implement the first interest rate hike of 2022, financial services companies continue to adjust their predictions for the remainder of the year.
Hikes will occur based on shifts in inflation.