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Forecasting the Wind: IPC's Expert Economist on the Impact of Inflation RatesOctober 31, 2023 | Shawn DuBravac, IPC
Estimated reading time: 1 minute
In the enchanting world of Shakespeare's plays, prophecies often set the stage for unforeseen twists and turns. Just as Macbeth could not have anticipated the tumultuous journey that lay ahead after encountering the three witches, the financial markets and policymakers find themselves in a similarly uncertain terrain.
Take prices, which rose sharply in 2022. The Federal Reserve was slow to respond. Although the rate of inflation has declined since reaching its zenith last year, it continues to exceed the Federal Reserve's 2% inflation goal. “Higher for longer” is likely the mantra for interest rates. This prolonged period of higher interest rates will have a ripple effect on various sectors of the economy.
A Historic Battle with Inflation
For the past 18 months, the Federal Reserve has been battling historically high inflation with annual inflation peaking in June 2022 at 8.9%. Core price inflation, which excludes volatile categories like energy and food, peaked a few months later in September 2022 at 6.6%. Both measures remain high. Annual inflation is still running at 3.3% and core prices are 4.7% higher than they were a year ago.
The Federal Reserve was sluggish to respond to rising inflation, thinking that price increases were only temporary. The delay forced the Fed to move abruptly with a series of aggressive rate hikes. The Federal Reserve raised its target rate by 25 basis points in July, its 11th hike in 16 months. The Fed’s target federal funds range of 5.25–5.5% is the highest level since January 2001.
The Implications of Higher Rates
Tightening monetary policy has pushed interest rates up across the entire yield curve, and this impacts the economy in several ways. The yield on the 10-year Treasury bond is the highest it has been in 16 years. The rate was over 100 basis points lower just this spring. The elevated interest rates can act as a dampener on both consumer spending and business investment, leading to slower economic growth. Additionally, the shift in the yield curve can alter the risk-reward dynamics for various financial assets, influencing investor behavior.
To read Shawn's three ways that higher interest rates are likely to impact the economy in the coming year, click here.
This article originally appeared in the fall 2023 issue of IPC Community.
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