Whether the Federal Reserve decides to raise interest rates for the first time in nine years Thursday or waits until December, the action is now baked into expectations.
Once the rate hike happens, the Fed is likely to keep its benchmark rate, which has been near zero since December 2008, at levels that remain historically low.
That’s not to say things will remain the same. Slowly, borrowing costs across the economy will begin rising, and it will cost a bit more to buy a car, a house or to send a kid to college.
That’s not a bad thing. It’s a sign that the U.S. economy is strong enough to withstand what will be slow-climbing higher rates.
On the current path, rates aren’t going up very much or very quickly.
Dean Croushore, chairman of the economics department at Virginia’s University of Richmond
Here are three things to keep in mind about the changing rate scenario, regardless of whether it happens Thursday or later this year:
Watch what she says, not does
Fed Chair Janet Yellen will hold a news conference following the end of a two-day meeting where the rate decision will be made. Financial markets know the Fed wants to begin raising rates so that the economy begins a return to normalcy. What markets want to hear, however, is what the Fed considers “full employment” and when it expects the labor market will be so tight that wages will go up as companies compete for workers.
In other words, details about the Fed’s thinking are as important as the action.
“What it means for the economy, it really is not that significant,” said Dean Croushore, chairman of the economics department at the University of Richmond in Virginia and a former Fed economist. “I think the economy is definitely strong enough for them to start on this path. But it’s not exactly growing like crazy and we don’t exactly have strong inflation.”
Show me the inflation
The Federal Reserve has two missions: to promote full employment and to contain inflation, which is the rise of prices across the economy. Ideally, it wants inflation to grow at an annual rate of 2 percent. Economists at PNC Financial Services in Pittsburgh expect an inflation rate of just 0.3 percent this year because of the steep drop in energy prices. But they forecast an inflation rate of 2.2 percent next year as the economy further strengthens.
“Inflation is below the Federal Reserve’s target but is not moving further away from it,” Stuart Hoffman, PNC’s chief economist, said in a Fed preview Wednesday.
When it comes to inflation, expectations are as important as the actual rate. Business decisions made today are based on assumptions about what a dollar can purchase a year or two from now. It’s why the Fed’s expectations and views are important.
With the inflation rate so far from the 2 percent target, the Fed is under no strong pressure to raise its benchmark interest rate this month.
China a wild card
Another factor that may give the Fed pause is the turmoil in China’s financial markets and signs of a deeper-than-expected slowdown in Asia’s top economy. While China doesn’t impact the United States greatly, its economy accounts for about 15 percent of the global economy, so it will spill into the world economy, which more broadly affects U.S. exports and the value of the U.S. dollar.
Almost “all the data on the U.S. economy pre-date China’s currency devaluation, which rattled financial markets and accentuated concerns about slow global growth,” cautioned Stephen Oliner, a 25-year veteran at the Fed.
Now a resident scholar at the American Enterprise Institute, a conservative think tank, Oliner expected the Fed to hold off on a rate hike because “it makes sense to wait for data that aren’t stale.”