Interest rates news you shouldn’t ignore

Interesting news came out today about the future of interest rates. Those that are planning on financing large purchases should pay attention.

Charles Plosser, the president of the Philadelphia Federal Reserve Bank, revealed today that the Federal Reserve should increase interest rates from current range of near zero to 2.5% within a year. The Fed would sell $125 billion of assets for each 25 basis point increase in the funds rate. Meaning, at the end the Federal Reserve would have taken back $1.25 trillion. For those worried about inflation, this is a good thing. It’s basically  removing money from the system.

This of course comes as a surprise to many, myself included. Considering the quantitative easing tactics employed by the Fed and the state of the economy, many expected this move to happen much later in 2012 and 2013.

There is speculation as to why the sudden change in attitude from the FOMC. Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, commented that they are aware of the strong increases of short-term inflation the past few months and assured that it would not last long. Lockhart was most likely alluding to their plan to increase the federal funds rate. Perhaps the Fed is getting worried about inflation as well.

Some economists argue that raising interest rates currently would cause growth to stop and revert back. However, recent measurement indicating the growth of the US economy may also be playing a part in the Fed revealing these new planned actions.

Raising rates will have  a wide variety of effects on the economy:

  • Inflation hedges such as Gold and Silver will definitely take hits as increasing interest rates lowers projected inflation rates (see Loanable Funds Model)
  • Confidence in the US Dollar will improve, increasing it’s exchange rate value
  • Not the best news for bondholders
  • Money and loans will become harder to procure overall as banks will most likely tighten up lending
  • Will most likely spur reactionary economic policies from other countries

Remember, this is only a statement and not yet a decided policy. The FOMC will still vote on it in their next meeting.

This goes to show just how powerful the Federal Reserve is at moving markets and affecting economies. Unfortunately there is really nothing we can do about it. All we can do is prepare ourselves as best we can.

photo credit

Leave A Comment