What Is The Impact Of the Fed Rate Hike On The US Economy? A Brief Explainer.
In an effort to combat inflation as it hits its highest point in 40 years, the US Federal Reserve Bank raised interest rates for a third time by 0.75 percentage points, putting the federal funds rate in a range of 3.0% to 3.25% in September 2022.
To strengthen the dollar, the rates are anticipated to rise until they reach 4.4% by the end of this year.
The rising inflation is at its peak and has disrupted the domestic market of the US.
At the time of inflation, prices rise for everything including food, gas, rent, retail, etc., and if the unemployment rates are also on the rise, then the economic stability of the US is severely jeopardized.
When economic stability is threatened that’s when the Federal Reserve comes into the picture and helps keep the economy stable by increasing interest rates.
the Fed is in charge of overseeing the country's monetary and fiscal policy, which entails managing the money supply in the economy. Raising interest rates is the central bank's main instrument for reducing inflation, reducing demand for goods and services, and slowing the economy.
The Federal Open Market Committee (FOMC) establishes a target range for the federal funds rate (the fed rates) at its regularly scheduled meetings. This rate serves as a benchmark for the interest rates that major commercial banks of the country charge one another for overnight loans.
The Fed increased the interest rates for the sixth time in November 2022.
The US is the most powerful country in the world, in terms of military strength as well as economy. So, any changes in the federal funds rate affect both, the domestic market as well as the global market.
When the fed increases interest rates, it does so to make sure that the cost of lending across the economy increases as well. As a result, everyone from mega-corporations to consumers has to pay more as the interest rates skyrocket.
The financial system of any economy comprises its banks, lenders, stock market, investors, insurance firms, regulatory authorities, as well as everyday consumers. Changes in the fed fund rates affect them all, some positively and some negatively.
For example, higher market interest rates negatively affect stock and bond markets. How?
The cost of doing business increases for public and private enterprises when the Fed raises interest rates. Public companies' revenues and profitability may decline over time as a result of increasing costs and less business, which could affect both their growth rate and stock values. And when interest rates rise, the price of bonds falls, and vice-versa.
On the other hand, higher interest rates may be profitable for people having a savings account. How? When the interest rates increase, banks increase the deposit on account earnings as well. Because of this, the Annual Percentage Yields, checking, certificates of deposit, and money market account also increase.
However, interest rates on loans and mortgages also rise, negatively impacting consumers. It also reduces the demand for loans, as no one wants to pay higher interest rates.
The fed rates hike is also related to unemployment. As companies experience a decline in demand as interest rates rise, it leaves them with no choice but to freeze their hiring processes. Some businesses even begin downsizing by firing employees during such times.
Inflation and interest rate increases are occasionally required for the stability and sustained growth of the domestic economy. However, it is still uncertain how the Fed rate hike would affect the US and global economies in the long run.