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Updated 10:46 16/06/19

US Interest Rates rise again as economy stands its ground

Liam Sheasby

By Liam Sheasby, News Editor

15 Jun 2018

The Federal Reserve announced its second interest rate of the year on Wednesday, pushing rates up from 1.75% to 2%. The move was widely expected and brings the US back to inflation levels last seen just before the Great Recession began in 2008.

Following the news of the rate rise, the S&P 500 index of US stocks fell 11 points before rebounding, while the 2-year bond yields and the US Dollar both gained value. The price of gold dropped to $1293.05 – the lowest it has been since May 21 – but this can partially be attributed to a stronger Dollar. Prices have since climbed back up to $1299.97.

Jerome Powell, the Chairman of the Federal Reserve, said in his press conference: “The main takeaway is that the economy is doing very well.

"Most people who want to find jobs are finding them, and unemployment and inflation are low.”

The US has a 3.8% unemployment rate, and the Fed are predicting 3.6% by the end of the year. The Reserve impressed upon those in attendance that the US economy is approaching a ‘normal’ level, meaning they can and will be less hands-on in the not-too-distant future. He also suggested there would be a further two increases to the interest rate this year.

While those figures are right, the low inflation comment is a bit of a stretch. At present US inflation is at 2.8%; over a percent higher than the old interest rate and only just under one for the new. The Consumer Price Index recently announced that the rising inflation had pushed up consumer prices to the point that any wage increase for nonsupervisory workers in the US has effectively been wiped out in the last 12 months. Powell called this “a bit of a puzzle” but added: “You will see wages go up.”

The rate rise is designed to keep pace with inflation and rein it back towards the Fed’s 2% target, but it’s a balancing act for economists. If you’re too cautious in tackling inflation and raise rates too slowly you cause a devaluation of the Dollar and people’s earnings and savings – as inflation is currently doing at a slow but steady rate. The problem is that increasing interest rates too quickly can choke off economic growth by ramping up borrowing costs. This not only affects companies but also the public, in terms of car payments, mortgages, and credit cards.

As interest rates increase, so do the annual payments of interest on the national debt. The chart below shows the current and predicted debt levels. Debt is nothing new to major economies, and they fundamentally operate on the basis that they’re a government and can be trusted to owe people for the greater good, but too much causes a loss of confidence and stalls an economy.

While the news is a mix of good and bad, it’s a good time for investment gold. Bullion does well in situations of Negative Real Rates. This is a period where inflation and interest rates are both rising but the gap isn’t closing. The window offers investors a chance to take advantage of the improved currency (in this case the US Dollar) and to buy gold. Interest rate rises are few and far between, so inflation can pull away from it again. Having bought gold, the investor is better prepared to protect their wealth than someone with their savings in a bank.

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