The situation of individuals against inflation… The Fed, which started the tightening period with the 25 bps interest rate hike in March, decided to continue on its way with 50 bps in May. The Fed, which remains in a paradox that cannot ignore the inflation issue at the point of avoiding economic recession phenomena, is expected to continue its current tightening momentum with 50 bps in June. While consumer behavior and spending tendencies in developed country economies erode due to negative real incomes in the face of inflation, the main phenomenon is how long the policies of the central banks will stop inflation and whether it will cause stagnation in the economy while doing this.
The known fact is that real interest rates, which are currently negative against high inflation, negatively affect the wealth and savings of households. With the tight financial conditions brought by the central bank, real interest rates will increase, loan and mortgage rates will increase, and the price of stocks will decrease with the increase in the risk-free interest rate.
Different effects on interest rate dynamics… It is a well-known fact that a central bank like the Fed has moved forward in the direction of lowering inflation from high levels in the past, with sharp rate hikes that will put the economy into a serious recession, and has tolerated the recession for a certain period of time. In the 2016-2019 model monetary tightening, the Fed did not have to deal with a factor such as high inflation. The Fed is trying to make inflation manageable by creating a serious slowdown in demand. This situation, especially in the housing sector, will create the effect of increasing interest rates and reduced demand, and will have an effect on the decrease in prices. Of course, this situation will have an impact on the assets held, on the change in the value of the houses, and it will be difficult to sell the houses bought at high prices profitably. While mortgage rates rise in the US, the slowdown in the housing market will be an inevitable phenomenon.
Economic balances… It is known that the Fed has set a level close to 2.5% as the long-term target funding rate. While the interest rate hike in May brought the funding rate to 1%, the 1.5% band will be reached with the next 50 bps increase in June. This shows that when the 50 bps interest rate standard is considered in the following months, it is close to reaching the neutral interest rate, which is assumed to be in equilibrium with economic growth, inflation and employment.
Conclusion? If there are signs of slowdown in economic growth, it is thought that the Fed may slow down in advancing the course. The most important indicator of this is the employment market. The effectiveness of the Fed's current policy tightening in such an environment will emerge if inflation falls and marginal effects are avoided. That is, how much of the inflation comes from out-of-control global supply dynamics, how much of it comes from deteriorated pricing, consumer/producer behavior and demand phenomenon? Unless the economy is in a recession, the Fed will be more comfortable raising rates, but will need to review it when the risk of a recession rises.
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