The Federal Reserve has sent a clear signal that the era of ultra-low interest rates will end in 2022.
What’s happening Rates have been close to zero since March 2020, when government leaders around the world shut down the economy to slow the spread of the coronavirus. But the Fed predicted that the benchmark interest rate could rise to 0.9% in 2022, in addition to announcing a faster end to the emergency bond purchase program.
The policy pivot, which comes with inflation rising at the fastest pace in nearly four decades, could have major ramifications for markets and the economy. But Paul Donovan, chief economist at UBS Global Wealth Management, said it was important to separate price hikes from what wouldn’t help. As borrowing costs are expected to rise. “If you look at the real cost of capital in the broader economy, it would still be very low,” he said.
Before the outbreak of the Corona pandemic, the Fed’s target interest rate was between 1.5% and 1.75%. This was also very low by historical standards. But at the end of 2007, before the financial crisis, interest rates were at 4.25%.
Donovan does not believe that this move will have a profound impact on inflation, noting that many of the reasons that led to higher prices this year – including the jump in energy prices and the cost of used cars – are related to the effects of the epidemic and have nothing to do with the bank’s policy. central.
“In very short, the Fed wants to make sure that rates are not too low when the economic recovery is complete, so it has the ammunition to fight another crisis,” he added, according to CNN.
But this does not mean that prices will continue to rise. Donovan thinks that as Americans exhaust their savings from the pandemic, inflation will start to fall “very sharply” on its own.
What does all this mean for the markets? Donovan said the situation would be different if the Fed wanted to raise interest rates to curb economic growth. But that’s not what he sees happening here. “It is more about setting the scene when we return to a more normal economic cycle…the Fed is not on a campaign against growth,” he added.