Financial markets, consumers brace for additional rate hikes
At its November meeting, the Federal Reserve continued to extol the strength of the U.S. economy. In the third quarter, the economy grew at a robust annual rate of 3.5 percent. Consumer spending – which accounts for more than two-thirds of all economic activity – grew by 4 percent, its fastest pace in nearly four years. The national unemployment rate is at 3.7 percent, the lowest level since 1969. Annual wage growth is at 3.1 percent - the first time since April 2009 that wage growth has exceeded 3 percent.
However, economic growth and prosperity often carries a cost – inflation. Inflation is the year-over-year increase in prices for goods and services. In moderation, it simply represents a driving consumer demand for goods and services that helps propel our economy forward. But left unchecked, inflation can send consumer prices skyrocketing.
The Fed is tasked by Congress as the decision-making body for U.S. monetary policy. Through the management of the benchmark fed funds rate – upon which short-term debt is often based – it seeks to manipulate spending, investment, employment and inflation to promote economic growth. By gradually raising interest rates, the Fed raises the cost of borrowing, making it more expensive to purchase goods and services. Higher costs gently tap the breaks on economic growth and inflation, preventing the economy from overheating.
The core Personal Consumption Expenditures Index, or PCE, is the Fed’s preferred method of tracking inflation. This index measures the annualized change in prices paid by consumer households for goods and services, excluding the more volatile and seasonal food and energy prices. The Fed’s target rate of inflation is 2 percent – a rate it deems, over the long-term, is the ideal healthy balance between price stability and economic growth.
For most of the past decade, inflation has averaged just 1.6 percent, reflecting the lackluster economic growth since the 2007-2009 Great Recession. But with the recent surge in economic growth, inflation has been rising. In January, inflation was at 1.6 percent. Two months later, in March, inflation quickly rose to 2 percent, where it currently stands.
The ideal pace of interest rate hikes allows for a steadily growing economy that keeps excessive inflation in check through targeted and measured rate hikes. Since December 2015, the Fed has enacted eight 0.25 percent rate hikes to the fed funds rate, including three so far this year. However, the Fed appears convinced that the ongoing strength in the economy, labor market and wage growth will continue to push consumer prices even higher. The markets currently assign a 75 percent probability of a further rate hike in December, the fourth this year. In addition, the Fed has at least three more rate hikes penciled in for next year.
But President Trump, along with many supporters on Wall Street, contends the Fed’s planned rate hikes are not all necessary. Inflation has yet to exceed the Fed’s 2 percent target rate and appears to be contained. Also, they argue, America’s trade disputes and a weakening global economy act as economic headwinds to gradually curtail U.S. economic growth. Thus, a December rate hike – and at least three more next year – are not necessary and place undue risks on U.S. economic growth.
Regardless of which side of the argument you believe – the Fed’s or Trump’s – the Fed remains independent of Presidential and Congressional influence in managing its directives. For now, absent a sudden collapse in economic and financial conditions, both Wall Street and American consumers should prepare for more interest rate hikes from the U.S. Federal Reserve.
Mark M. Grywacheski, Investment Advisor
Opinions expressed herein are subject to change without notice. Any prices or quotations contained herein are indicative only and do not constitute an offer to buy or sell any securities at any given price. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets, or developments mentioned.
Quad Cities Investment Group, LLC is a registered investment advisor with the U.S. Securities Exchange Commission.
