050 – Last Wednesday, June 14, the U.S. Federal Reserve (FED) decided not to raise interest rates during its meeting; however, it was announced that during the second half of 2023 it will raise interest rates at least twice, by 0.25% each. But, why is FED looking to raise interest rates?
Thank you for reading this post, don’t forget to subscribe!
To understand the answer, we must go back to the beginning of the COVID-19 pandemic, when Donald Trump’s government granted society an economic aid package in order to boost consumption and avoid a recession in the North American country. While it is true that in the first instance it was a wise measure, in the long term it caused the United States to have a high level of inflation, reaching close to 8%, the highest recorded in the last 40 years in the country; by the end of May 2023 it was at 4%, thus marking a downward trend over the last 11 months.
In view of this situation, the government of Joe Biden and FED have had to take economic measures in order to decelerate the growth of inflation; among these measures are the increase in interest rates and the decrease in the issuance of money, or monetary base, by FED.
These economic measures have been taken because, as dictated by economic theory according to Milton Friedman, when there is a significant increase in the amount of money in the hands of the public and there is no significant increase in production, consequently, the prices of products and services increase. However, it should be taken into consideration that this measure by FED has been taken since March 2022, by which time interest rates were at 0.13%, while they are currently at 5% and 5.25%, the highest recorded since 2007
In the first place, many banks in the US banking system have had to announce their bankruptcy, since, as interest rates rise, the price of bonds falls and new bonds offer higher yields, so that the banks themselves are forced to sell the old bonds or even clients with a large position decide to withdraw their money from the banks before obtaining significant losses.
Secondly, the main securities market, such as the New York Stock Exchange (NYES), has been hit due to short-term expectations regarding macroeconomic indicators and the measures to be taken by the FED. In this case, the financial markets have reacted in a volatile manner to the Federal Reserve’s announcements, since, as no immediate impact on macroeconomic indicators has been observed, the situation is expected to extend and therefore there is uncertainty.
The recent announcement by FED could be interpreted as good news for the traditional financial markets, but since it has already been announced that interest rates will be raised again during the remainder of the year, the reading by investors is that the situation is not yet under control and therefore they decide to take refuge in other assets, such as precious metals.
Charles Schwab principal Michael Zarembski indicated that “while CPI of 4.0% is well below the June 2022 peak of 9.1%, it may provide the Fed with a rate hike announcement following today’s Federal Open Market Committee (FOMC) meeting, consumer inflation remains well above the Fed’s stated target of 2.0%.”
On the other hand, traditional financial markets have not been the only ones affected; the cryptocurrency market has also been “hit” by the Fed’s announcements. If we look at the behavior of Bitcoin (BTC), which represents about 40% of the total capitalization of cryptocurrencies, we can observe a downward trend in the vast majority of the announcements made by the FED, as can be seen in the following graph:
As can be seen, after the 10 announcements made by the Fed between 2022 and so far in 2023, the trend of the BTC price is clearly downward, although in various scenarios the price rises and then falls. If we take into consideration the maximum price recorded from March 2022 to June 19, 2023, we can see how the price of Bitcoin went from $48,280 to $26,600, which marks a drop of 44.95%.
The basic principle of traditional finance is that as money becomes more expensive, investors will decide to turn to other markets or sources of savings, such as gold. In this particular case, it can be seen how both traditional finance and the New York Stock Exchange and the cryptocurrency market have been affected by rising rates.
It is expected that during the second half of 2023 there will be mixed behavior in the financial markets, everything will depend on the internal factors that happen in the United States and how they affect the world, since the dollar is the reference currency for transactions between countries.
Interest rates are expected to close 2023 at around 5.6%, U.S. GDP is expected to grow at around 1% and inflation could be around 3.2%. However, it is important to note that the increase in interest rates could bring with it a recession, not only for the United States but also for the world, and the FED will have to act with caution to avoid the collateral effects that could arise in the long term.