Interest Rate Increase

Interest Rate Increase

 

     The Federal Reserve raised interest rates ¼% in September. They are also expected to raise rates again before the end of the year. Whether that happens or not will depend on various factors in the economy. So, what has caused the Fed to raise rates, and why now?

     We have seen an increase in inflation. This has primarily been driven by increased gas prices caused by the Iran conflict. The conflict was expected to be over by now with oil and gas prices back down to their lows of 2025. Unfortunately, prices have stayed high due to risk and limited supply coming out of Iran and neighboring countries affected by the Strait of Hormuz closures. Since the world runs on oil, the conflict has driven up not only the cost of oil and gas, but also energy and travel costs as well.

     The overall inflation rate is currently 3.4%, which is close to where it was a year ago. The expectation was that inflation was going to continue to decline toward the Fed target of 2%. The lowest inflation rate we have seen recently was in December 2025 at 2.7%.

     In addition to price stability, the second Fed mandate is to support full employment. Full employment is seen as 4% unemployment. At the current 4.1%, we have effectively reached full employment. This means the US economy is extremely strong even with higher oil and gas prices. The Fed’s concern is the economy getting too “hot,” and they want to use their power to “cool” it off. They do this with monetary tightening through increased interest rates.

     Combining the two mandates of the Fed, you can see how they feel comfortable raising rates to combat inflation, and they aren’t worried about the economy faltering. This has given them the confidence and conviction to raise rates. The expectation is that inflation will still be persistent for at least the next several months, and that is why they are expected to raise rates again later in the year.

     While interest rates do affect inflation and employment, they don’t have direct control over either. The Fed’s objective is to not be the cause of a problem. So, if inflation does rise, they want to be seen as a force of stability. If the labor market is too strong, they don’t want to be seen as fueling the fire.

     Ironically, the expectations are that these rate increases will likely be reversed in the next year. We will have to wait and see what actually happens. For now, enjoy a slightly better rate on your savings and money market accounts.