With the Fed raising rates, how high will rates go?

With the Fed raising rates, how high will rates go?

The media keeps front and center the issue of how many interest rate increases by the Federal Reserve are coming and how high those increases will be. However, no one knows for certain how far up interest rates might go.

The interest rates for which there is sometimes clarity are the federal funds rates. The federal funds rate is the rate that banks, credit unions, and other institutions charge each other for overnight loans of reserves deposited at the Federal Reserve (the Fed). The Federal Reserve uses its operations to get these super short-term rates within its target range. It does not directly set the rate. The rate is negotiated between institutions on the open market.

Because the Fed’s target rates affect the costs lenders incur, changes indirectly affect the rates lenders charge. Again, the Fed does not directly set rates for auto loans, mortgages or interest paid on bonds. Those rates are determined on the open market.

…the Fed does not directly set rates for auto loans, mortgages or interest paid on bonds. Those rates are determined on the open market.

In many cases, the Fed will signal to the market what changes to the target range they have in mind. As a result, market absorbs this information and rates change before the Fed acts. Often, there is a disconnect between the Fed’s action and how one might think interest rates would change. That was the case for the most recent .75% increases. Instead of interest rates rising, many key rates fell.

The Fed announced it would raise its target .75% on June 15^th and announced another .75% increase on July 27^th. According to Mortgage News Daily, rates on 30-year fixed loans were at 6.28 on June 15^th yet were down to 5.13 as of July 29^th.

A similar effect occurred with the interest payable on U.S. Treasury securities. For instance, on June 15^th, five-year U.S. Treasury bonds yielded 3.38% and by July 29^th, the rate had dropped to 2.7%. If you had abandoned those bonds out of fear of higher rates, you would have missed an increase in the value of a bond over that period.

There is a media lesson here that is important. In mid-June as those rates were reaching recent high-water marks, the media was awash with stories about how the Fed would raise its target and these rates would continue higher. It was an easy narrative to tell. Inflation is high so the Fed must raise rates and therefore other rates will follow. That may be the case going forward but so far that storyline has been dead wrong.

The point here isn’t to mock yet another set of forecasts that didn’t materialize and say don’t listen to those people that got it wrong. It’s to encourage you to note how short term all this discussion about rates is and encourage you to stay focused on the long term. You shouldn’t care who was right about such short-term market moves. You do not need a short term forecast of rates, inflation, the economy or the stock market to have a good outcome if you have a sound plan and stick to it.

Making News…

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