When Will the Fed Raise Rates?

The Fed Will Continue Raising Rates Through 2017

When will the Fed Raise Rates
Federal Reserve Chair Janet Yellen testifies before the House Finance Committee in the Rayburn House Office Building November 4, 2015 in Washington, DC. Photo by Chip Somodevilla/Getty Images

The Federal Reserve expects to raise the fed funds rate to 1.5 percent by the end of 2017. It will normalize it at 2 percent in 2018 and raise it to 3 percent in 2019. That means it will raise its benchmark rate 1/4 point either November 1  or December 13. Those are its remaining 2017 meetings. For more, see U.S. Economic Outlook.

The fed funds rate is now 1.25 percent. The Fed last raised it 1/4 point at the June 2017 Federal Open Market Committee meeting.

 Most FOMC members think conditions are robust enough to warrant it. Members are pleased with recent strong jobs reports

The Fed has been gradually raising rates since December 2015. That was the first rate increase since June 29, 2006. The rate had been at virtually zero (between 0 to 0.25 percent) since December 16, 2008. The Fed lowered it to combat the Great Recession. For details, see Current Fed Funds Rate.

The fed funds rate directly affects short-term interest rates. These include the prime rate, credit card interest rates, and savings account rates. It indirectly affects long-term rates, such as mortgages, corporate bonds, and ten-year Treasury notes. The Fed will raise those rates when it sells its holdings of Treasury notes and bonds. The Fed acquired $4 trillion of those through its Quantitative Easing program. Find out When Will Interest Rates Be Raised? and What Is the Relationship Between Treasury Notes and Mortgage Interest Rates?

Why the Fed Is Raising Rates Now

The Fed is anxious to return rates to the healthy 2 percent level. It wants to get the economy out of a possible liquidity trap. That's when families and businesses hoard cash instead of spending it. Low interest rates don't give them much incentive to invest. The only way out of a liquidity trap is to raise interest rates.

 

The Fed also wants to raise rates because it's been talking about it for more than a year. In response, forex traders expected the dollar's value to rise. To take advantage of that, they shorted the euro. That strengthened the dollar 25 percent in 2014 and 2015. The strong dollar hurt exports and slowed economic growth. It also created lower import prices. That reduced the chance of inflation. If people expect prices to stay the same or drop, they have less incentive to spend now. They know their purchase might cost less in the future. 

Fed Chair Janet Yellen explained at the November 17, 2016, Congressional meeting that the Fed isn't affected by the election outcome. Fed Board Members look at economic data. But Donald Trump has promised expansionary fiscal policies. That means the Fed will probably follow contractionary monetary policy to prevent inflation. That's because the economy is growing at a healthy rate. Tax cuts and increased spending in 2017 will overheat the economy, causing inflation. For more, see Which Phase of the Business Cycle Are We Currently In?

How Do the Fed's Actions Work to Increase Interest Rates?

The Fed increases interest rates by raising the target for the fed funds rate at its regular FOMC meeting.

This Federal interest rate is charged for fed funds. These are loans made by banks to each other to meet the Fed's reserve requirement. Banks set these rates themselves, not the Federal Reserve.

These rates rarely vary from the target rate. That is because the banks know that the Fed will use its other tools to pressure them to meet its target. These tools include the discount windowdiscount rate, and open market operations.

On September 18, 2007, the Fed began a 16-month drive to dramatically lower rates, from 5.25 percent to less than 1 percent. That was in response to tightening credit markets brought on by the subprime mortgage crisis.

By January 2010, investors began wondering "When will the Fed raise interest rates again?" In response, the Fed announced its exit strategy, which focused on tightening the money supply using everything BUT the fed funds rate.

The Fed wanted to keep that rate low since it affects variable-rate mortgages. The housing market had not yet recovered. There was a 15-month pipeline of foreclosures that kept housing prices down.

To fight the recession, the Fed kept the fed funds rate unchanged as long as possible. It increased the discount rate and cut back on other programs. That kept the prime rate and variable-rate mortgages low, supported the housing market and kept bank credit available. For more, see How Does the Fed Raise or Lower Interest Rates?

How High Will Interest Rates Go?

Once the Fed raises the fed funds rate, how high will it go? The Fed expects to raise it to 1.5 percent by the end of 2017. It will increase it to 2 percent in 2018 and 3 percent in 2019. The Fed forecasts inflation to remain around 2 percent until 2022. That's because it will make sure that inflation is no worse than that. Here are 5 Steps to Take Now to Protect Yourself from Fed Rate Hikes.

Historically, the fed funds rate remains between 2-5 percent. The highest it's ever been was 20 percent in 1981 to combat stagflation and an inflation rate of 12.9 percent. That was an unusual circumstance caused by wage-price controls, stop-go monetary policy, and taking the dollar off of the gold standard. For more, see U.S. Inflation Rate: Current Rate, History, and Forecast

Former Federal Reserve Chairman Ben Bernanke has said that the most important role of the Fed is to maintain consumer and investor confidence in the Fed's ability to control inflation. That means the Fed is more likely to raise rates than lower them.

Find out what Wall Street traders think the Fed will do with the Fed Funds Futures as a Predictive Tool.

Other Important Interest Rates