The Federal Reserve Board just announced it was raising interest rates, with the warning that it will probably be doing so again soon.
The home of the U.S. Federal Reserve Board in Washington, D.C. Photo: pedrik, CC
On September 26, U.S. Federal Reserve Board chairman Jerome H. Powell announced the Fed will be raising interest rates to a range between 2 and 2.25 percent. That’s a 12.5% increase at its high end. It also said it plans to continue raising rates in the future.
In making the announcement, Powell called attention to the U.S. economy having “a particularly bright moment” right now. While he acknowledged the increased rates would have some effect on business and personal borrowing, he emphasized the rate increases were not meant to slow growth. “My colleagues and I are doing all we can to keep the economy strong, healthy and moving forward.”
The comment about slowing growth is itself a little unusual, since the Fed’s increasing of interest rates is always about managing economic growth. Many economists also feel reining economic growth back in somewhat is long overdue. There are also fears about what will happen as the trade war with China begins to hit American pocketbooks hard starting as the Christmas buying season heats up.
The Fed has been monitoring actual GDP growth of the economy versus consumer spending for some time. In August, the Atlanta Fed lowered its projected Q3 growth for the economy to 4.1 percent, a suggestion that the backbone of the economy – real business growth – is in fact slowing. The personal consumption expenditures (PCE) price index increased by 2.0% in June, even subtracting out the turbulent food and energy parts of the number. The PCE index is one of the Fed’s main points to monitor inflation. The 2.0% increase in June was the first time the PCE was up by that much since April 2012.
The labor market, particularly at the lower economic levels, is also tightening up significantly. That could cause employers to have to raise wages to keep good employees as well as to attract new ones.
Rising wages, especially in an economy with strong consumer demand, is likely to put further pressure on inflation. Prices are also already creeping up from a strong surge in energy costs this year of over 10% year-to-year. Those energy costs end up building into the costs of all products as they are moved and shipped around the country.
The other wild card in the economy is the impact of the trade wars Trump initiated with China and other countries. With China providing many of the items Americans buy particularly for the upcoming holiday shopping season, tariffs associated with at least some of them will drive those prices higher. The big hit on tariffs Trump has imposed now looks like it won’t hit until after Christmas, just because buying and stocking for the holidays is already well under way. But that is more a matter of when, not if, prices are going to go up for many things consumers like to buy.
China is also expected to add further tariffs of its own as the trade war increases. While that will be on imported goods from the U.S., China’s approach is to slow buying of many items from targeted regions of the U.S. That could cause serious harm to certain sectors of the economy, such as for pork and alcohol, just to name a few. That will mean lower revenues for those businesses, further weakening the underlying former strength of the economy.
There are also early warnings that the long-running housing boom is slowing in the U.S., at least in certain bellwether areas. Housing purchases drive many segments of the economy, so this could hurt too.
Increasing interest rates also will have major implications on U.S. Government borrowing for its own key projects. With 2017’s tax reform act having given major tax breaks to corporations and the wealthy, and those tax breaks not having produced much if any economic growth, the U.S. is now on its way to hit a $1 trillion deficit by the end of this year. That is a far more rapid acceleration than had been projected earlier this year, when it was thought the deficit might not grow that high until 2020.
Economists are also projecting that even without these other pressures, the long boom market which originated under President Obama will soon begin to cool in early 2019. It is also expected to slow even further by the time of the next Presidential election, in 2020.
With this latest announcement, the challenge for the Fed is finding a way to cushion what could be a very difficult landing for the economy, beginning next year. One can also expect Donald Trump to continue to pressure the Fed Chairman to keep bank borrowing rates down, just as he did with this latest one. Trump said that, “We could do other things with the money,” and said he was “not happy” with the higher rates.
Whether Trump is happy or not, the economy – with all the pressures on it – is soon about to slow down. The only question is whether it will do so in a soft landing or a hard crash. With Congress and the White House seemingly disinterested in actively managing the economy in a positive way, it could be up to Fed Chairman Jerome Powell and his colleagues to keep us all away from the brink.