Don’t Celebrate Yet: Comments on the Fed’s Latest Interest Rate Hike

The Fed just raised the Fed Funds rate by 0.25% on last Thursday (June 29, 2006) for the 17th time in the hopes of containing the upward march of inflation. The Fed Funds rate (short term rate that the Fed sets) is now stands at 5.25%–the highest in five years.

The financial markets welcomed the news via a jump in the Dow by 217 points (and the NASDAQ by 63 points) on Friday. Why should the financial markets celebrate rising interest rates? The response normally would have been a drop in the market. It had to do with the softer tone of the Fed statement relating to the announcement – the Fed Open Market Committee was hopeful that a slowing economy might cool down inflationary pressures, and may not need to raise rates further.

My feeling –hold the champagne, the celebration may be premature. The Fed did not shut the door on at least another increase in the Fed Funds rate in August or later. The timing of the next rate increase will depend on how inflation and the strength of the economy fare in the coming weeks. In the next several weeks we need to keep our eyes on the Consumer Price Index (CPI), the Core Rate of inflation (the CPI minus energy and food prices), and job growth data.


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