Last month, the Federal Reserve, the highest and most powerful financial institution in the United States, put a pause on interest rate hikes after ten consecutive increments. This pause gave some sort of relief to the market.
However, the Federal Reserve is expected to hike interest rates in July in an effort to combat inflation. Inflation has been running at a 40-year high, and the Fed is under pressure to take action to bring it down. There are a few reasons why the Fed is likely to hike rates in July.
First, the economy is still strong. The unemployment rate is low, and wages are rising. This means that businesses are still hiring and spending, which is contributing to inflation.
Second, inflation expectations are starting to rise. This means that people are starting to expect prices to continue to rise in the future. This can become a self-fulfilling prophecy, as businesses raise prices in anticipation of higher demand.
Third, the Fed has already signaled that it is committed to raising rates. In the minutes of the Fed’s June meeting, policymakers said that they were “strongly committed” to returning inflation to their 2% target.
What shall we expect from July’s hike? Higher borrowing costs, a weaker stock market, and an increase in the U.S. dollar.
Increasing interest rates affects the cost of borrowing. Businesses and consumers will have to pay more to borrow money, which could lead to slower economic growth. This is what the Fed wants. Slowing economic growth slows consumer demand, thus, inflation as a result. The Fed is willing to inflict economic pain on the American consumer for the sole sake of reducing inflation to its nominal target.
This economic pain will lead to higher unemployment rate. This is because they make it more expensive for businesses to operate, which can lead to layoffs. Additionally, higher interest rates can make it more difficult for people to find jobs, as they have less disposable income to spend on goods and services.
Higher interest rates could lead to a sell-off in the stock market, as investors become less willing to take on risk. So far, the stock market seems to be in bullish territories thanks to AI stocks that are carrying the whole value of the S&P 500. But higher interest rates reduce the value of investments, which prompts investors to sell off their investments to cut their losses. Those who apply the principles of value investing, however, will seize the opportunity to reinforce their positions by buying stocks at a discount price.
Increasing interest rates will increase the value of the U.S. dollar. A stronger dollar could make it more difficult for U.S. exporters to sell their goods abroad, which could also lead to slower economic growth.
The Fed and other financial institutions have been predicting a recession in late 2023 and sometimes in early 2024. The magnitude of the expected recession remains a debate among economists and financial professionals. The Federal Reserve predicted a “mild recession,” or in more sophisticated terms, a soft landing, while others predicted a hard landing.
Everything depends on how aggressive the central bank will want to be about interest rates. One thing that’s certain is that the Fed will get back again on the rates-hike trail to keep tightening the credit market.