Federal Reserve Keeps Pushing Up Rates!
On September 21st, the Federal Reserve (Fed) raised the Federal Funds Rate by 75 basis points. The fifth increase for the year pushed the target rate from 2.25% to 3.00% – the highest rate since February 2008.
The hike follows the release of August’s inflation numbers – at 8.3%, inflation has remained above 8% for six months. Along with quantitative tightening, the Fed is increasing the Funds Rate to curb inflation, which is at a four-decade high.
The basis for several benchmark lending rates, the Federal Funds Rate, is the target rate for banks to lend other financial institutions funds to meet overnight balance requirements. This rate is historically lower than the Discount Rate, which is the rate Federal Reserve banks charge commercial banks and other institutions for short-term loans.
Among the rates based on the Federal Funds Rate are the Discount Rate, the Secured Overnight Financing Rate (SOFR), and Prime Rates.
Since March of this year, the Fed has raised the rate by 300 basis points (3.00%), with another 75-point raise anticipated during the Fed’s November meeting and a 50-point increase in December. This will bring the target rate to 4.25% – 4.50%. You have to roll back to December 2007 to find a comparable rate.
Wall Street’s reaction to the Fed hike was to sell, with the Dow Jones Industrial Average, S&P 500, and Nasdaq Composite dropping 1.7%, 1.71%, and 1.79%, respectively, on the day of the Fed announcement. Markets have continued to slide as bankers and investors rebalance their portfolios and price in the possibility of future rate hikes.
The current cost of capital is shocking compared to the 0.14% median rate of the previous ten years, but we are still well below historical highs. Between January 1972 and December 2021, the median Funds Rate was 5.12%, peaking between 1980 and 1981 at a staggering 20%.
Current commercial lending rates are hovering around 6%, and government-backed rates are around 5%. Following the Fed’s actions, banks will begin to adjust their lending rates higher, increasing the cost of capital.
For each $1,000,000 borrowed, increasing loan rates by 1% can increase annual debt service by approximately $8,000. On a $10,000,000 note, debt service can increase by $80,000 yearly – not a small number.
Early indications are that the rate hikes by the Federal Reserve are having the desired effect. The annual inflation rate has dropped from a June high of 9.1%. While the indications are promising, the Fed is determined to get inflation back to the 2% target, so we can expect rate hikes into early 2023.
At the Federal Reserve’s July meeting in Jackson Hole, Wyoming, Chairman Jerome Powell said, “We are now moving our policy stance purposefully to a level that will be sufficiently restrictive to return inflation to 2%.” In a recent interview, the CEO and president of the Federal Reserve Bank of Cleveland, Loretta Mester, stated, “it is far too soon to conclude that inflation has peaked, let alone that it is on a stable downward path to 2%.”
Could the target rate hit 5.00% in 2023 – possibly. It will largely depend on the stubbornness of inflation. Predicting where rates will peak is difficult, but we can be confident that they will end the year around 4.25% and stay there well into 2023 – and maybe into 2024.
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