The Federal Reserve has raised interest rates 10 times in the last 18 months — and this week could be No. 11.
Between high inflation, rising unemployment and a volatile stock market, a lot is riding on the outcome of the June Fed meeting due to conclude on June 14.
What is being decided at the June Fed meeting?
The headline decision that the Fed will announce after its June 14 meeting is whether it will keep the level of the federal funds rate between 5% and 5.25% — or raise it by 0.25 of a percentage point, or “25 basis points” in Fed lingo.
The Fed is considering raising interest rates to try to bring down the inflation rate, which is currently at 4.9% year over year, according to the latest consumer price index report from the Bureau of Labor Statistics (BLS). That’s more than double the Fed’s 2% inflation target.
The federal funds rate affects other interest rates throughout the economy, and those affect inflation because they increase the cost of borrowing. William Fox, a professor emeritus of economics at the University of Tennessee Haslam College of Business, explains it as a matter of balancing supply and demand.
“If demand is too strong relative to supply, then prices go up,” Fox says. “They raise interest rates to try to slow down and reduce demand for interest-sensitive items.” Those include cars, housing and credit card spending.
However, raising interest rates too much can slow down the economy to the point that lots of people lose their jobs. That’s a real concern for the Fed, given that the latest employment report from the BLS showed an uptick in the unemployment rate.
Fox says that Fed meetings are about more than just interest rate changes.
“It’s not just making decisions — they’re getting together and talking about the conditions of the economy,” he says.
After every other Fed meeting, the Fed releases a Summary of Economic Projections (SEP) that shows its outlook on employment, economic growth, inflation and future interest rate policy — and a new SEP is due after the upcoming meeting.
What might the Fed’s Summary of Economic Projections show?
The centerpiece of the SEP is the “dot plot,” a chart in which the members of the Federal Open Market Committee give their opinion on what the appropriate federal funds rate should be at the end of this year, next year and the following year.
The median interest rate in the dot plot is an important signal of where rates may go in the near future, although it’s not a prediction. The current level of the federal funds rate is the same as the median level from the March 2023 SEP, and investors and economists will be interested to see if that’s still the case in the June SEP.
The SEP also includes the Fed’s predictions for gross domestic product growth in addition to unemployment and inflation rates over the next three years — which are potentially of interest to investors who are wondering when inflation will settle down, or when the next recession is coming.
How might the June Fed meeting affect markets?
The Chicago Mercantile Exchange’s FedWatch tool uses data from futures markets to assess the odds of interest rate changes. It currently shows a 78.1% chance that rates will be left unchanged on June 14, and a 21.9% chance of a 25-basis-point increase.
But David Andolfatto, the chair of the economics department at the University of Miami Herbert Business School, isn’t sure that the market’s prediction will be right.
“Personally, I would not be surprised at another 25-basis-point hike,” he says. “Inflation is still running pretty hot, relative to the Fed’s 2% inflation target.”
Fox says that if the Fed defies expectations and raises interest rates, that would have a negative effect on the stock market, as well as the market for short-term debt securities such as Treasury bills.
Andolfatto says a stock market selloff is a possibility if rates go up, but the market could also have the opposite reaction. “They might equally well conclude, ‘OK, now they’re done,’” he says. The implication is that if the Fed makes one last rate increase and signals that it’s the last one for the time being, that could fuel a relief rally in the stock market.
Where might interest rates go from here?
At the May meeting, Federal Reserve Chair Jerome Powell avoided definitively saying that the Fed intends to pause further interest rate hikes. But he did acknowledge that the interest rate level set at that meeting — the current rate level of 5% to 5.25% — was the same as the maximum interest rate level forecasted by the previous SEP.
Powell also called attention to the fact that the Fed’s statement from the May meeting removed a sentence from previous statements that said that “some additional policy firming may be appropriate.” In other words, the Fed wilfully omitted a sentence suggesting that more interest rate increases may lie ahead.
“There’s a sense that the Fed has pretty much come to the end of its hiking cycle,” Andolfatto says, although he doesn’t have a personal prediction of where interest rates will go in coming months.
Markets don’t seem to be convinced that the Fed is completely finished raising rates, though. FedWatch data shows that a slim majority of investors expect another 25-basis-point increase by the end of the following Fed meeting on July 26.
Fox is also doubtful that we’ve seen the last of the 2023 interest rate increases.
“What I expect is likely additional increases in the fed funds rate in coming months — but minimally, no decrease on the Fed’s part until it has much clearer evidence of a significantly slowing economy,” Fox says.
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