By the time you read this, the Federal Open Market Committee (FOMC) will have made a decision on the general direction of interest rates. More than likely, this committee, consisting of the Board of Governors of the Federal Reserve System and a rotating group of the twelve Federal Reserve Bank presidents, will vote to raise the overnight Federal Funds rate by one quarter of one percent.
As I have mentioned in several of my columns, the Fed only controls the one rate, the Fed Funds rate, which is the interest rate at which banks and credit unions borrow and lend to each other on a daily basis. This one rate, in and of itself, is unimportant. The critical component is the message the Fed is sending to the rest of the world as to their views of the U.S. economy.
The Fed Fund rate has not changed since December 2008, which was the depth of the Great Recession. Rather than setting a specific rate at that meeting, the Fed established a “near-zero” target range of zero to 0.25%. Since then, the FOMC has monitored many analytics, but none more important than inflation and unemployment. The committee indexed specific inflation and unemployment rates to future rate increases.
These indices, which come from various federal agencies, have created problems for the Fed. First of all, the unemployment rate has reached the Fed’s goal, but inflation has not. Generally, interest rates will rise to slow down inflation, but the rate still hovers around 1%. However, there are more people unemployed or underemployed than reported, and our paychecks don’t seem to go as far as they did in the recent past. There seems to be a disconnect between government statistics and the real world.
Secondly, the push for higher rates are coming from the media, which knows almost nothing about economics, and banks, which want higher rates to raise their loan rates. I think the media’s preference for a rate change is so they can fill their around the clock schedules with so-called talking heads opining about what they would do if they were in charge (thankfully, they’re not in charge of anything.) The banks’ wanting higher rates is a head scratcher. Most bank and credit unions have too much cash and want to lend it. Higher interest rates will significantly slow down lending, especially in the real estate market.
Finally, we’re now living in a global world which means the Fed has to be concerned with the value of the dollar. The dollar’s value affects imports and exports which greatly affects our economy. It was easy in the old days when the U.S. was virtually the only economic powerhouse. But now with China, the European Community, and more recently South America and Africa with their vast natural resources, a small change in our Fed Fund rate reverberates around the globe.
Whatever the FOMC decides will be the subject of much discussion. The media talking heads will be at maximum volume. Presidential candidates will no doubt talk about either returning the U.S. to the gold standard or abolishing the Fed. I predict banks and credit unions will probably not raise deposit rates but probably not raise loan rates either. But don’t listen to me; I retired from the prediction business years ago.