Will the Economy Determine Fed Rate Increases?

The Federal Reserve’s Minutes of the Federal Open Market Committee (FOMC) for March 20 to 21, 2018, indicated the Board of Governors will increase the pace at which it raises rates. Open to speculation is whether rate increases will affect the economy or the economy will affect rate increases. It is possible that the Fed has set a course to reverse the policy to keep rates at historic lows as a means to keep the economy growing.

The prevailing objective of the Fed since the Great Recession is that low-interest rates and the purchase of bonds allow businesses and consumers to operate in an environment in which the cost of money is close to zero. This has spurred the corporate fixed income markets, which in turn has allowed many companies to invest in expansion. Consumers also have benefited as the price of auto loans, as an example, have been as low as 0% APR. An increase in rates may well curb both types of borrowing.

Rate increases cannot be based on inflation, at least that is what the Fed has indicated. However, it will continue to raise rates, even if inflation remains in a 1% to 2% range, particularly when the cost of fuel is backed out.

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According to the FOMC minutes:

The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.

While inflation remains low, questions about the labor market are a balance between low unemployment and slow increases in wages. A large body of evidence shows the purchasing power of Americans has not increased much in years. Higher fuel costs, which have been the trend recently and may accelerate going forward, may erode discretionary income. Marry this with capital markets that make corporate use of the capital markets riskier.

It is possible that the Fed would do more for the economy if it does not raise rates at all, at least for the time being.

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