Economy

Fed Holds Line on Rate Hikes, But Concerns Linger

Fed and inflation

Last Wednesday, at its most recent meeting, the Federal Reserve held back on raising interest rates.  The move, or in this case, non-move, had been widely expected.

And it came in the wake of a rate hike that took the benchmark interest rate to a range of one percent to 1.25 percent in June.  That was the third hike in six months.  And as the Washington Post reported, the general expectation is that another rate hike will come by the end of the year.

The statement that came alongside the decision mentioned that the Fed is keeping an eye on the low inflation rates, noting that inflation rates are running below two percent.  That stymies the argument that the institution needs to boost rates in order to keep the economy from overheating.

And yet, looking forward, there are likely to be rate jumps in 2018 and 2019, the Fed has stated.  Indeed, numbers last week show that (via initial estimates) GDP growth accelerated in the second quarter to 2.6 percent (full-year annual growth was 1.5 percent in 2016). The main drivers were consumer spending and exports.  Keep in mind this is only an initial estimate, and revisions might swing either way.

But should the momentum be sustained, inflation will start to pick up.  If inflation picks up, so will rate hikes.  When rate hikes do come, the sword will probably be a double-edged one.  Higher rates translate into higher yields on savings and other accounts.  That may boost spending if consumers start to feel flush, and that they can handle the debt load they’ve already got.  Maybe.  And consumer spending has to rise if retailers and others are to survive and thrive.

But against a backdrop of higher chargeoffs, which are worrying the major banks, it could be the case that consumers may not take that extra money and go spend it, choosing instead to work off debts or keep funds in the bank to get some yield.  Incidentally, some of those very same banks that are seeing higher chargeoffs are hitting new highs in the stock markets, with the Dow notching record performance even today.   Earnings outperformance has been a key driver, but investors are really holding out hope, it seems, for deregulation to help boost results even further.

But back to consumer spending.  If it doesn’t pick up that means that the economy, and especially retailers, will not see a boost to their top lines.  At the same time, these firms will have higher costs in place (tied to higher rates).  Thus, less investment to go around to sink into new operations and staff.

Looking toward Washington to salve any hiring or business slack (Remember the huge infrastructure spending plan that was supposed to come down the pike?) should it become pronounced, would be no panacea, either.  With higher interest rates comes a boost to deficits, as the government will fork over more in order to borrow money.

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