One of the hallmark pain points of life in 2022 has been inflation. With consumer prices rising 9.1% in June, American households are feeling the heat. Invariably, then, the Federal Reserve has the unenviable task of modulating benchmark interest rates to cool escalating prices. However, it must do so carefully, leading to many analysts forecasting what the central bank will do this coming Wednesday.
For a quick recap, the Fed effectively controls key interest rates through influencing the federal funds rate. Set by the Federal Open Market Committee (or FOMC), the federal funds rate is essentially the interest rate that banks charge each other for the purposes of borrowing or lending their excess reserves overnight.
As the Fed increases the funds rate, it shrinks the supply of money, which in turn raises borrowing costs. Should the Fed decrease the rate, the money supply expands, reducing the cost to borrow money. Therefore, the federal funds rate directly affects interest rates, the trajectory of which reverberates throughout the economy.
According to the latest data, the purchasing power of the dollar declined 12.92% (as a result of inflation) between the start of Covid-19 through June 2022, roughly equivalent to 13 cents on the dollar. However, it’s not just the long-term erosion but the pace of its acceleration that investors should focus on.
In 2021, the dollar lost 6% of purchasing power. In just the first half of this year, this metric declined by 5.3%. Therefore, the Fed presumably must raise interest rates, but by how much? Several analysts have voiced their opinions on the matter.
A Kaleidoscope of Forecasts for Interest Rates
According to the Washington Post, the Fed is set to raise interest rates this Wednesday in the latest effort to combat rising inflation. Several leaders within the central bank are leaning toward a hike of three-quarters of a percentage point, mimicking the action they took last month. If so, the move would represent the fourth rate hike in five months.
About the only debate that exists is how far the Fed should go with increasing its interest rates to tame inflation. Fed governor Christopher Waller disclosed dismay at the latest inflation reading, calling it “a major league disappointment.” However, he also cautioned against going overboard, remarking that a “75 basis-point hike is huge.”
St. Louis Fed President James Bullard stated that a “hot” inflation reading for June “warrants pushing the target federal funds rate to a range of between 3.75% and 4.00% by the end of this year, a half percentage point higher than his prior year-end aim,” per a report by Reuters. However, Bullard was indifferent about the magnitude of the hike this month, so long as interest rates increased to an appropriate level by the end of this year.
Interestingly, some analysts state that the Fed must essentially throw the kitchen sink at the inflation dilemma. “The FOMC should be in five-alarm fire mode right now,” wrote Amherst Pierpont Securities Chief Economist Stephen Stanley on Wednesday. “Inflation is still accelerating on a month-to-month basis, the pressures are pervasive, and in recent months they are more and more focused in categories that tend to be persistent.
MarketWatch noted that futures pricing implies a 61% probability of a 100-basis-point increase in the FOMC’s target interest rate. That’s a massive jump of 7.6% odds for the same event posted just last Tuesday.
Why It Matters
Naturally, the trajectory of interest rates directly affects business sentiment, with higher rates cooling entrepreneurial or expansionary attitudes while lower rates may spark potentially speculative activities. Unfortunately, the Fed has an unenviable job of navigating an extremely delicate situation.
Per the Washington Post, the “Fed’s goal is to cool the economy in a way that reduces demand for new hires but does not cause employers to pull back so much that unemployment surges.”
“We don’t seek to put people out of work, of course,” remarked Fed Chair Jerome Powell at a June news conference. However, Powell must also thread the needle carefully as an inflation rate sustaining itself near double digits could be disastrous for the economy.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.