How Much Will the Federal Reserve Boost Interest Rates?
With inflation rising 7.5% compared to a year ago, the largest increase in forty years, the Federal Reserve is set to raise the federal funds interest rate. (This is the rate that banks are permitted to charge when they lend money to each other.) And when the Fed raises this rate, it inevitably leads to all interest rates rising, including mortgage rates.
Since inflation is defined as too much money, chasing too few goods, the Fed historically responds to inflation by making borrowing more expensive, therefore slowing the amount of borrowing and, therefore, spending by companies and individuals.
The only questions remaining is how much the Fed will raise rates and how many more raises will come in 2022. Normally, the Fed raises rates a quarter of one percent. But since they were caught off guard, predicting inflation to be very temporary (it turned out not to be), there is a possibility that the first raise of the year (in March 2022) could break with tradition and result in a half percent rise. More rate hikes are assured in the months ahead. Many analysts think the Fed will raise rates six or seven times this year.
Investing.com, one of the three largest financial platforms in the world, offers a valuable tool called the Fed Rate Monitor Calculator which predicts future Fed interest rate increases and decreases. Without getting too much into the weeds, the tool is based on the Chicago Mercantile Exchange (CME Group), the world’s largest financial derivatives exchange (where futures, stock options, interest rates, etc. are traded). It is based on “30-Day Fed Fund Futures Prices.” (This is an actual market where investors can speculate on where interest rates, commodities, or options will be within a 30 day time frame.) This market has proven to a good indicator, historically, of where rates are headed in the short term. The Investing.com tool allows investors to calculate the likelihood of upcoming Fed rate hikes, and how much they will be.
According to the tool, the Fed will raise rates at their March meeting. (The Fed meets 8 times per year, about every 6 to 7 weeks.) But by how much? Now the calculator is sending mixed signals. Through mathematical modeling, the Fed Rate Monitor Tool is predicting a 22.1% chance of a rate increase between 0.50 and 0.75 percent. But the chance of a rate increase between 0.25% and 0.50% stands currently at 77.9% (which again is the standard Fed rate increase historically). The tool is forecasting no chance of a 0 to 0.25 percent increase.
It will be at their May meeting, that things will begin to move quicker according to the tool. Again, the tool is predicting a zero percent chance of a hike of 0 to 0.25%. But his time the tool is also forecasting a zero percent chance of 0.25 to 0.50% increase. The prediction for May points to a 77.9% chance of a rate hike between 0.50 and 0.75%. And there is a 22.1% chance of a hike between 0.75 and 1.00 percent.
The predictions for the June meeting are even starker with no chance, again, of a 0.25 or even a 0.50 rate hike. Rather the tool is pointing to a 77.9% chance of a hike between 0.75 and 1.00%.
The July prediction ranges from a 075 to a 1.5% rate increase. The expected June and July forecasts would, if it occurs, be an unusually aggressive move by the Fed, perhaps an indication of how seriously they take the inflation data. The reason the Fed normally raises rates very slowly (a quarter of a percent), is to mitigate threats to the economy of sudden changes. Sudden sharp increases can slow the economy too much, and possibly lead to a recession.
Again, the prediction of significant rate increases in 2022 is an indication that the Fed is quite concerned with the state of the economy, particularly on the inflationary aspect.
Buckle up.