Just a few months ago, the idea of the Federal Reserve raising interest rates further was an unfathomable concept. Today, it’s being whispered among financial circles as a potential, albeit reluctant, option.
The Price of Inflation
For the Fed to consider hiking rates again, two things need to happen:
- A significant increase in inflation
- A shift in consumer and business expectations to believe that prices will continue to rise
Currently, inflation is still well above the Fed’s target of 2%. The persistence and magnitude of price increases have prompted growing concerns among policymakers.
Reluctant Hikers
Despite the inflationary pressures, Fed officials remain hesitant to tighten policy again. Most have indicated that interest rate cuts are the more likely next step. They fear that raising rates too soon could stifle the economy, especially since it is still recovering from the pandemic.
Nonetheless, it’s notable that the possibility of further increases is back on the table. New York Fed President John Williams acknowledged the possibility of hiking rates if necessary.
Echoes of the Past
Policymakers are keenly aware of the mistakes made by the central bank in the 1970s. Back then, the Fed raised rates to combat inflation, only to cut them prematurely, allowing the problem to resurface.
Data Dependence
For now, the Fed remains data-driven. It will monitor economic indicators to determine whether further rate increases are warranted. Any such move would be considered a “genuine shock,” according to Nicholas Colas of DataTrek Research, potentially causing significant economic turmoil.
A Minority View
Fed Governor Michelle Bowman remains the lone voice supporting rate hikes. She believes the Fed may need to tighten policy if inflation stalls or even reverses.
Market Implications
Fed funds futures markets currently price in no possibility of a rate increase this year. However, the market has had to adjust its expectations as inflation data continues to disappoint.
Conclusion
The prospect of the Fed raising interest rates further may seem remote at present. But persistent inflation could force policymakers to reconsider their current stance. As the situation evolves, investors are advised to be aware of that possibility and its potential market implications.
Data sourced from: cnbc.com
