Jeff MacLellan| Columbia Daily Tribune
Trying to figure out where interest rates are going is, to say the least, a difficult task. In the recent words of Jerome Powell, the head of the Federal Reserve Bank, “Forecasters are a humble lot with much to be humble about.” There are so many moving parts that determine the course of interest rates that it is virtually impossible to get all of the assumptions right when trying to determine the course of rates.
The Fed meets 8 times a year and helps set the direction of interest rates by setting the fed funds rate which is the interest rate that depository institutions lend reserve balances to other depository institutions overnight on an uncollateralized basis. The fed funds rate influences the direction and level of interest rates for all kinds of consumer borrowing from mortgage rates, personal loans, car loans, and credit card rates.
As a bit of background, the Fed has been raising the fed funds rate at an historic rate from near zero to its current level of 5.25%-5.5% in an attempt to curb inflation. They started raising rates in March of 2022 and last moved .25% in July of this year. They held steady at their September meeting and have two more meetings, one Oct. 31 – Nov. 1 and a final meeting for the year in December. Following are some of the significant factors that will influence the Fed in the determination of the next moves for the fed funds rate.
Inflation. The Fed relies on an inflation index called the Personal Consumption Expenditures Price Index (PCE). The latest reading for August of this year was .4%, which largely reflected the recent runup in energy prices. Core prices, which exclude food and energy, rose .1%, the weakest reading since 2022 according to the Commerce Department. Moreover, over the three months ending in August, the annualized rate of inflation was 2.2%, approximating closely the Fed’s desired rate of 2.0%. Clearly, as the rate of increase in prices moderates, that is good news for maintaining rates where they are. Should the rate of increase accelerate that would argue for further increases in rates and that would have the effect of tightening credit. This single factor is a primary indicator of the future course of interest rates.
GDP Growth Rate. This helps determine how fast or slow the economy is growing. The Atlanta Fed does a pretty good job of forecasting quarterly GDP growth and they currently forecast a robust 5.1% for the 3ed quarter. High growth argues for continuing to raise rates.
Unemployment Rate. The latest unemployment rate stands at 3.8%, a very low rate and an indicator of a strong jobs market. A strong jobs market implies higher wages as employers reach to hire employees in a tight labor market. This also argues for higher interest rates in an attempt to slow the economy and tighten the strong jobs market.
Oil Prices. The price of a barrel of oil translates into the price of gasoline at the pump. As we all know, prices at the pump have risen lately. Gas/diesel prices affect most everything in the economy because goods are transported probably various times from a raw material to a finished product available in a store or online. Rising fuel prices imply higher inflation as they are a factor in most everything we consume.
The foregoing is a very simplistic way of addressing a very complex issue. It is not that simple. The biggest message coming out of the Fed’s recent meeting was that they intend to hold rates higher longer than previously expected. The Fed is hoping for what they are calling a soft landing which implies a slowing in inflation down to its 2% target, a slowing of the economy without a recession and a tightening of the labor market. If you look at history, there are a couple of lessons out there. The first is that the Fed goes up the stairs when raising rates but takes the elevator when coming down. That is certainly the case they experienced during the Financial Crisis and the Pandemic. The second lesson is that big inflation shocks require painfully high interest rates that last for several years.
Forecasting interest rates is difficult at best and probably impossible. For instance, another factor that can affect rates is the worldwide geopolitical situation. Two years ago, who would have predicted two wars, one in Eastern Europe and one in the Middle East? Remember what Chairman Powell said, “Forecasters are a humble lot with much to be humble about.”
