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Interest Rates Hikes – Are They Cooling Down Inflation?

June 18, 2023

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Interest Rates Hikes – Are They Cooling Down Inflation?

The Federal Reserve, conscious of the worst inflation rates in decades, has diligently raised rates ten times since March 2022, aiming for a target range of 5%-5.25%, but paused its rate hikes last week. This policy aims to cool down the heated inflation, and it’s working. Sort of. Last Tuesday, the monthly Consumer Price Index report showed that the annual inflation rate had cooled more than economists expected in May.

Exterior view of a hot air balloon in the sky Rates Hikes
The CPI report shows inflation is cooling off. Photo by Aaron Burden on Unsplash

Investors and financial experts have also been closely watching the movement of U.S. Treasury yields, which dipped marginally last week, indicating a cautious investor climate.

Whilst full minutes and meeting reports won’t be released for another week or so, we can look at market activities in the last week to gauge investor sentiment.

Treasury notes dip

The yield on the benchmark 10-year Treasury note slightly decreased to 3.741%, while the 2-year Treasury yield saw a steeper drop of 2.3 basis points to settle at 4.581%. As bond prices and yields share an inverse relationship, this drop highlights a trend of investors bracing themselves for important economic updates.

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Oil prices decline

Meanwhile, oil prices recorded a decline ahead of the Fed’s policy decision. Brent crude futures sank 3.9% to settle at $71.84 a barrel, its lowest since December 2021. At the same time, West Texas Intermediate crude slid 4.4% to $67.12 a barrel.

Exterior view of an oil pump silhouetted against the sunset Rates Hikes
Oil prices fell to the lowest price since Dec 2021. Photo by Zbynek Burival on Unsplash

The dip in oil prices was fueled by rising global supplies and fears of slowed demand growth, emphasized by Goldman Sachs’ reduction in oil price forecasts. The bank predicts December crude prices at $86 a barrel for Brent and $81 for WTI.

Caution around traditional investments

The Fed’s rate hikes have historically fortified the dollar, increasing the cost of commodities priced in the U.S. currency for holders of other currencies, and subsequently applying pressure on prices. This, coupled with the anticipation of potential rate hikes resuming next month, seems to have investors on edge.

Meanwhile, despite the rising interest rates, the labor market remains robust. May witnessed an addition of 339,000 jobs, signifying a strong economy. However, we have to keep in mind that it generally takes at least a year for rising interest rates to significantly influence the real economy. Typically, this effect comes in the form of a slowdown in employment and consumer purchases.

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