How Will High Interest Rates Continue To Affect Us?

It seems that no matter what decision the Federal Reserve makes, investors will still be caught off guard.? In an interview with 60 minutes on February 4th, the Federal Reserve Chair Jerome Powell vowed that the central bank will proceed carefully with interest rate cuts this year. He said in the interview “We just want some more confidence before we take that very important step of beginning to cut interest rates”. It is yet another interesting turn, as the general sentiment among investors was there might be some immediate relief to the high interest rate environment. After the last several inflation measure reports pointed towards the “soft landing” the FED was hoping for. Powell's comments are beginning to make investors wonder what they can expect for a prolonged period of higher interest rates.?

The federal funds rate (which is the primary interest rate that the FED changes) is the interest rate at which banks lend reserves to each other overnight. It's like the economy's central control knob, manipulated by the Fed to steer growth and inflation. Raising the rate makes borrowing more expensive, slowing down the economy and potentially curbing inflation. Conversely, lowering it stimulates borrowing and spending, boosting growth but risking reigniting inflation.

The current 5.33% rate might seem daunting, since the federal funds rate hasn’t been this high since 2001. Even in 2008 it peaked at 5.31%. But a broader view reveals an interesting picture. While the past two decades saw exceptionally low rates, even hovering near zero at times, the historical average since 1954 sits at 4.60%. Whereas, post-2001 to today, the average rate was significantly lower at just 1.59%. This stark comparison is exactly why investors are monitoring the funds rate so closely. Given how rates being this high are being seen as something unprecedented.?

Navigating this new landscape demands a nuanced understanding of its potential impact. Businesses do face higher borrowing costs, potentially impacting expansion and investment. Consumers will also see reduced spending power due to pricier loans, impacting sectors like housing and construction. However, part of a nuanced approach is knowing that it's not all doom-and-gloom for the world's largest economy.?

Reflecting again on the higher rates experienced from 1954-2001, during that same time period GDP grew an average of 1.77%. Looking at GDP growth from 2001 to today, where there were lower interest rates, the average GDP growth was only 1.09%, while the historical average since 1954 currently sits at 1.55%. So, while interest rates do bear a lot of implications in the shorter term, having high interest rates over a long period of time is not a sign that the economy as a whole will continue to weaken, or that continuing to carry low rates for another twenty years will bear any sort of success.?

Part of this discussion is highlighting the negative effects that higher interest rates may have in the short term. Of course this is the case since the intention of having higher interest rates in the first place is to reduce spending. While the other half of the discussion is showing that it is not a simple good-versus-bad scenario.?

Simply looking at GDP growth, which is supposed to show economic growth as a whole, has shown that there is no initial correlation between interest rates leading to greater or weaker GDP growth. There is still money to be made betting on short-term interest rate changes and how it will affect the stock market, but many long-term investors and economists will tell you. There is a bit more than waiting for what Jerome Powell might have to say.

As the Fed walks the tightrope of balancing these forces, understanding the "why" behind their approach empowers individuals and businesses to make informed decisions. Whether you're a business owner planning investments, a young professional managing finances, or simply curious about the economic landscape, staying informed about the federal funds rate and its implications is crucial. It is just one other piece of the puzzle in order to navigate a dynamic economic environment.