This news report is coming from the United States of America (USA) where the dollar has just hit three months high against a basket of currencies. This happened after the chairperson of the US Federal Reserve Bank Jerome Powell conveyed that the central bank’s present probability to increase interest rates is much higher than it was before. Powell has warned that regaining the earlier inflation rate of 2% is a long and arduous process. The American lawmakers were informed by Powell that the Federal Reserve is ready to introduce stringent measures necessary to regulate and control price rises. The degree of being stringent would depend on the incoming intel. In comparison to last year’s larger interest hikes by the Federal Reserve, it slowed down its speed of interest hikes at the last two meetings, wherein tightening up to 25 basis points was done.
It is time for Americans to get prepared for higher interest rates so that long-term inflation targets can be met. Chris Zaccarelli who is a Chief Investment Officer at Independent Advisor Alliance in North Carolina expresses that such an announcement from Powell was already anticipated and that the market was rife with such news. He says that now Powell is overtly talking about setting a high target for interest rates. Pertinent to mention here is that the Federal Reserve’s focus is on the Terminal Federal Funds Rate.
WHAT IS THE TERMINAL FEDERAL FUNDS RATE?
The Terminal Federal Funds Rate is the final or ultimate interest rate that is fixed by the Federal Reserve as its long-term target for the federal funds rate. The federal funds rate is used as a benchmark for setting interest rates on automobile loans, mortgages, etc. A committee in the US by the name of the Federal Open Market Committee (FOMC) is given the responsibility to determine current as well as terminal federal funds rates. The committee extensively considers future economic conditions like unemployment, Gross Domestic Product (GDP), and inflation to arrive at a terminal rate. The terminal rate, thus is the end interest rate sought to be achieved by the Federal Reserve at the end of the monetary policy cycle. Contrary to the terminal rate, the current federal funds rate is the interest rate at which lending and borrowing of money in the overnight market take place by the depository institutions. In simple words, while the terminal rate is a long-term target, the current rate is a short-term target. The terminal rate is also referred to as a ‘Neutral Rate’ since it is the interest rate where the full level of employment is met and the prices are stable too.
Another important aspect associated with the terminal rate is that it is fixed as a range such as 4% – 4.25% rather than being fixed in a single figure. It is expected by many experts that the Federal Reserve will slow down the hikes, both in size and frequency, by the middle of 2023. It is also anticipated that if the economy would show symptoms of recession, the Federal Reserve may cut interest rates later in the year.
Powell has assured that the fixation of interest rates will be done meeting by meeting after observing the requisite data and its effect on inflation and economic activity.