Interest rates have been a key topic of debate among analysts and investors alike for years now. Most major economies have been attempting to recover from the financial crisis by using vast monetary policies, most of which include incredibly low-interest rates. However, most central banks are beginning to recognize the issue with this strategy. Although low-interest rates can help business activity, debt markets and investment, it can have an adverse impact on inflation.
After the Fed tapered off quantitative easing measures in 2014, the dollar began surging in value. Although there were some benefits to this rally, most analysts agree that the strong dollar continued to impact businesses negatively, in particular manufacturers and exporters. Consequently, import prices took a dip, and one of the Fed’s most important metrics began to fall alongside import prices. The Fed watches inflation figures more than most other metrics, as is its purpose stipulated by law. When inflation doesn’t do well, the Fed must make adjustments.
The issue now is the speculated gains of the dollar. After the Federal Reserve raised rates in December, the global economy took a nose dive due to unrelated factors. The dollar finally ended its hot streak, and US business enjoyed the brief period of a weaker dollar. However, with Britain’s withdrawal from the European Union, investors are now fleeing for safer waters, primarily the US. Although the US economy is also suffering from the global economic slowdown, as are US bond yields, the US, and its assets appear much healthier and more lucrative compared to the other struggling major economies in the world. Now the dollar is making gains yet again as investors flee both the euro and pound.
Speculators have been waiting for months now for another interest rate hike. The Fed has stated on multiple occasions that the inflation rate would be a primary indicator of a coming rate hike. Although US inflation came in below the Fed’s target rate of 2 percent at 1.6 percent in May, it was a marked improvement compared to last year. This was likely due to the weaker dollar. Speculators began increasing their predictions for a coming rate hike. However, now that the US is being seen as a safe haven for investors, the dollar is appreciating, which might lead to inflation dipping once again.
The Federal Reserve is now in a tough position. Most analysts agree with the central bank that interest rates need to increase, but higher interest rates will strengthen the dollar even further and depress inflation to an even greater extent. Markets believe that US inflation will tick down in the coming months themselves. The five-year, five-year forward rate is now sitting around 1.43 percent, down from the 2 percent it reached last year and its historic average of 2.36 percent. The Federal Reserve now has little room to maneuver. If it raises interest rates sometime soon, inflation will take a major hit, in addition to the damage to US inflation from the struggling global economy. But if the Fed does not raise interest rates, a bubble may grow out from the low interest rate environment and growth may remained subdued.