With such shocks something of a rarity for the central bank, it’s got economists worried about just how high the federal funds rate might actually go.
And while interest rate rises can be a good thing in some circumstances, they can be especially bad in others.
So, let’s take a closer look and see what’s really going on.
Why Are Interest Rates On The Rise?
Ever since the Great Recession of 2008, interest rates in the United States have remained both steady and extremely low.
But with the easing of Covid restrictions toward the end of 2021, consumers have again begun spending money in larger quantities.
However, with an increase in demand and a shortage of goods to go around, prices have also gone up as well. Unfortunately, this has led to a worrying spike in inflation too.
Indeed, other causes have conspired to impact the growth of inflation right now. The invasion of Ukraine by Russian forces has led to oil and gas prices rising sharply in recent months, while the global supply chain crisis hasn’t helped either, with production costs and the price of raw materials adding to inflationary pressures.
As a result, government policymakers and central banks have increased interest rates in a bid to get the problem of runaway inflation under control.
The reason for raising interest rates is that it dampens economic activity throughout the economy. This is achieved by increasing the cost of credit, which has a knock-on effect of limiting spending, as well as incentivizing individuals and institutions to save instead of borrow.
As such, the Federal Reserve went against expectations in June, raising the federal funds rate 75 bps – instead of the anticipated 50 bps – from 1.00% to 1.50%-1.75%.
The problem with this, however, is that it can also work to slow the economy down too much – leading some economists to speculate that, in this case, the cure might actually be worse than the disease.
Will Interest Rates Continue To Rise?
Despite the fact that governments and monetary bodies are still raising interest rates across the board, real interest rates remain negative. The real interest rate – that is, the difference between the nominal interest rate and inflation – stands at around -1.45% today
With the real interest rate this low, it’s tempting to think that there’s still some way to go before banks decide to ease up on rate hikes.
However, that view could turn out to be wrong. There are, in fact, a couple of reasons to suggest the opposite might be true.
To begin with, pre-pandemic growth wasn’t exactly rampant. The Fed had actually initiated three interest rate cuts in the second half of 2019, and the backdrop of a US-China trade war was stoking-up fears of a slowing economy too.
Indeed, things have gotten worse since that time. The massive stimulus package that the government doled out during the virus outbreak must be paid for somehow, and the continued supply chain problems, energy crisis, and Chinese real estate debacle aren’t improving things either.
Secondly, it seems that economic activity has already slowed to a level that might not necessitate any further interest rate hikes anyway.
In fact, key indicators within the commodity markets suggest this is the case. For example, important building materials are all down lately, with copper losing around 35% of its value from its high, and steel and lumber are each down over 50% too.
What’s really shocking, though, is that US consumer confidence is also at some of its lowest levels for decades, and, despite economists not yet calling the present situation a recession, it certainly appears to feel like it is to most people.
Given all that, the wisdom of upping interest rates when the economy is so close to stagnation may no longer make any sense.
So How High Will Interest Rates Actually Go?
Today’s current level of 1.5%-1.75% is the highest it’s been since September 2019, when the rate was set at 2.00%.
Interestingly, interest rates between 2008 and 2015 were effectively set at zero, and have never risen above 3% at any point after that time.
However, don’t be fooled into thinking that low-interest rates are historically the norm. In fact, it was in 1980 that the federal funds rate reached its highest ever level. At the time, the country was reeling under double-digit inflation, and the central bank saw no other option than to raise interest rates to 20% in March of that year.
Prior to that record level, interest rates were pretty much always in the range of around 5% to 15%. That period was marked by the official end of the gold standard in 1976, although it had ceased to exist effectively by 1973.
Indeed, the decade was certainly interestingly from a fiscal point of view, with recessions and oil embargoes the background to events and decision-making going on within the Fed.
The same could also be said of the 1980s too. Another recession, and the monetary policies of Paul Volcker, largely defined those ten years, which also saw high-interest rates compared to present-day values.
But will history repeat itself again?
At the moment, that doesn’t look likely. Our current predicament isn’t nearly as precarious as those occurring in the latter half of the 20th Century, and experts aren’t even close to suggesting that we’d enter that sort of territory soon.
For instance, the national debt held by the US in the 1970s was significantly lower than in 2022. Indeed, government debt back then was around 35% of GDP, whereas today, that stands at about 125%. Household debt, too, was much lower, at roughly 50% of GDP compared to 75% of GDP now.
This difference is important. It would mean that, with interest rate increases like we saw in the 1970s and 1980s, the service repayments on this national debt would quickly rise to astronomical levels, triggering a debt crisis of unimaginable proportions.
In fact, this is a situation that many other developed countries face around the world, and the avoidance of such may be a key reason why interest rates have remained so low for so long. France, for example, has a debt of 350% of its GDP, eclipsing even that of the apparently fiscally-irresponsible government of Greece.
However, while there’s still no place for complacency, there’s also little reason to fear any steep increases anytime soon. Indeed, the opposite might be about to happen, with the era of rising interest rate hikes over before it even got underway.