The Fed Dials Up Interest Rates by 0.25%

Economy

The Fed Dials Up Interest Rates by 0.25%

The quarter-point hike sets the target rate between 1.75 percent and 2 percent. Chief Economist Scott Brown discusses implications.

June 13, 2018

As expected, the Federal Open Market Committee (FOMC) raised short-term interest rates following its June policy meeting. This is the second increase this year and the seventh in the current tightening cycle. As with every other FOMC meeting, the Fed released revised economic projections, including a new dot plot (senior Fed officials’ forecasts of the appropriate year-end federal funds rate) and Chair Powell conducted a post-meeting press conference. Heading into the meeting, the key question for investors was whether there will be one or two more rate increases by the end of the year. For insight, market participants look to the revised dot plot.

The Fed began publishing the dot plot in early 2012 with the intent of providing the public with the range of policy expectations. The Fed stresses that the dots “should not be viewed as unconditional pledges” and “are subject to future revisions in light of evolving economic and financial conditions.” The dots’ range should be the primary focus, and currently, the majority of dots are split between three and four rate total increases this year (which would mean one or two more raises in 2018); the median has now edged up from three to four.

The underlying rate of consumer price inflation has remained moderate. So why is the Fed raising rates? In the last couple of years, the Fed’s rate increases were about getting monetary policy back to a neutral position following an extended period of exceptionally low rates – taking the foot off the gas pedal. Now, it’s about tapping the brakes in an attempt to get the economy to slow to a more sustainable pace. Soft landings are difficult to achieve, and the risks of a policy error (moving too rapidly or too slowly) naturally rise in a late-cycle economy. Fed officials generally believe that the federal funds rate will be raised above a neutral rate in 2019 and 2020.

A number of emerging economies may face difficulties as the Fed raises short-term rates, but the Fed’s focus is on the domestic economy. Tighter monetary policy ought not to have a significant impact on the U.S. economy in the short-term, but higher intermediate and long-term interest rates (a consequence of rising short-term interest rates) should dampen economic growth over time. There are no signs of a recession on the horizon, but the risks of a possible downturn are likely to rise as we head into 2019.



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