In December of 2016, the Federal Reserve raised the Federal Funds Rate rate by 0.25% for the first time in over a year, which is still a historic low, to a rate of 0.50%. The Federal Funds Rate is the interest rate banks at which banks charge each other when giving overnight loans to one another. Banks use these loans to meet the 10% excess reserves amount set by the Fed so banks do not suffer a bank failure when customers want to withdraw their money. This rate thus influences the interest rate at which banks are charged when they take out loans from the Fed which is called the discount rate. As banks get charged more to take out loans for themselves, this leads interest rates to rise for us as well. The Chair of the Federal Reserve, Janet Yellen, also projected three more rate hikes in 2017 but many economists wondered if these hikes were even likely to happen and if so, when?
As we look at the recent 2016 fourth quarter report on the Gross Domestic Product (GDP), total amount of all goods and services produced over a specific time period, it showed only a 1.9% increase and a measly 1.6% increase for the entire year. Even in pass years in 2014 and 2015, the overall GDP rate has been 2.4% and 2.6% respectfully. This hardly qualifies as a robust economy. So how could the Fed be looking at increasing rates? Well, lets take a quick look at two indicators that the Fed uses in making their decision on rate adjustment.
Employment. The Bureau of Labor and Statistics reports that the unemployment rate has fallen from 6.6% to a present day value of 4.7% since 2014. This is below the Fed’s target value of full employment of 5%. Additionally, the U.S. has generated close to 8 million jobs including the recent surprising jobs report of 235,000.
Personal Consumption Expenditures (PCE). The PCE measures the price changes of consumer goods and services which is reported by the Bureau of Economic Analysis. This is the primary inflation index the Fed uses since it is more consistent with the long term plan of monetary policy. The PCE includes a wide range of expenses of homes across the country. Unlike the Consumer Price Index, data is collected by surveys from businesses , not consumers. The current rate is at 1.74% which is still close to the Fed’s 2% target rate. Note that the Fed does use other indexes such as the Consumer Price Index but it does tend to be more volatile and less reliable in their view.
As the FOMC concludes their first part of their two day meeting, it is highly probable for the Fed to once again raise rates again after these strong reports that consistent with their dual mandate of maximum employment and price stability.