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Federal Reserve Increases Rates
The Federal Reserve raised interest rates by 0.25 percentage points (25 basis points), moving its target range from 3.50%–3.75% to 3.75%–4.00%. The vote was unanimous, and this is the first increase since 2023. Higher rates raise the cost of borrowing money. The Fed sets the rate banks charge each other for overnight loans. When that rate rises, banks pass the higher cost through to credit cards, auto loans, business loans, and eventually mortgages. Borrowing gets more expensive, people and businesses spend less, and slower spending takes pressure off prices.
Purpose for Raising Interest Rates
The Federal Reserve has a dual mandate of price stability and maximum employment. Prices have not been stable recently. The annual inflation rate stands at 3.4%, and prices are roughly 29% higher than they were in February 2020, just before the pandemic began. For perspective, an item that cost $100 at that time now costs about $129. The Fed raised rates to bring inflation back toward its 2% goal sooner.
What’s Driving Inflation?
Inflation has run above the Fed's 2% target every year since 2021. The largest driver today is energy. The war in Iran has constrained oil supply through the Strait of Hormuz, and energy prices are up 16.3% over the past year, with gasoline up 27.4%. Because oil is used to make and transport almost everything, those costs spread through the economy; airline fares alone are up 23.4%. Higher tariffs on most of the countries we trade with have raised costs for producers as well.
How Many Hikes?
Likely at least one more. The Fed's updated projections (the "dot plot," where each official marks where they expect rates to go) show 16 of 18 policymakers expecting at least one more quarter-point hike this year. Markets are pricing one more hike in 2026, with further increases into 2027. Goldman Sachs Asset Management expects the Fed to skip its October meeting because it falls so close to the midterm elections, then hike in December, depending on inflation reports and energy prices. Its read is that the Fed is not planning an aggressive tightening cycle.
Past Hike Cycles
From 2004 to 2006, the Fed raised rates 17 straight times, a quarter point each, taking rates from 1.00% to 5.25%. From 2015 to 2018, it made nine hikes over three years, taking rates from near zero to 2.25%–2.50% as the economy recovered from the financial crisis. Most recently, it hiked aggressively from 2022 to 2023, reaching 5.25%–5.50% to fight the highest inflation in four decades. That cycle responded to an overheating economy. This one responds to a supply shock, which makes the 1970s the better comparison. Oil shocks drove inflation then, the Fed eased too early, and inflation expectations became unanchored. Getting prices back under control took rates of nearly 20% under Paul Volcker and a recession in the early 1980s. That history explains why the Fed is acting on energy-driven inflation it would normally look past.
How Does This Affect My Investments?
Cash: Money market funds and high-yield savings accounts move with the Fed's rate, so savers earn more. Bonds: When yields rise, existing bonds lose value because new bonds pay more. Long-term bonds are hit hardest; short-term bonds reprice faster and carry less of that risk.
Stocks: Higher rates raise companies' borrowing costs and make future earnings worth less today. Markets had already priced in the hike itself; the selling started during Chair Warsh's press conference, when he signaled more hikes could come. The S&P 500 dropped 1%, heading toward its lowest close since July, and the Dow fell 1.7%, led by financial stocks.
Dollar and gold: The dollar index rose 0.6%, and gold futures fell 0.6%, because higher yields make assets that pay no interest less attractive.
Effect On Rate Markets
The 2-year Treasury yield, the one most sensitive to Fed expectations, rose 7 basis points to 4.73%. The 10-year rose to 5.01%, and the 30-year was essentially flat at 5.36%. The day before the decision, the 10-year hit its highest level since 2007. The 10-year matters most for households because fixed mortgage rates follow it rather than the Fed directly. Mortgage rates have been climbing since March and are now at their highest in over a year. Variable-rate debt, such as credit cards and student loans, feels the hike first.
Effect On Government
Total federal debt is about $39.8 trillion, but most of it does not reprice when the Fed moves. Notes and bonds carry fixed rates until they mature. Another $7.73 trillion is intragovernmental debt, which is the government paying itself. The part that reprices is Treasury bills (short-term debt maturing in a year or less), which total $6.99 trillion. A 0.25% increase on that amount adds about $17.5 billion a year, or roughly $1.5 billion a month, once those bills mature and are reissued. The bigger cost is market yields: as maturing notes and bonds are refinanced near 5%, interest costs rise well beyond the direct effect of the hike.
What To Look Out For
September CPI (October 14): This is the next check on whether energy costs are spreading into other prices. Oil and the Strait of Hormuz: If the conflict escalates again, energy prices could jump and the odds of more hikes would rise. Next Fed decision (October 28): Forecasters are split on whether the Fed acts in October or waits until December. The signal that matters most is core inflation. If energy cools and core stays near 2.4%, the Fed can likely stop after one more hike. If core starts climbing, energy is spreading through the economy and this cycle runs longer.
Conclusion
The Fed's first hike since 2023 shows it is no longer willing to wait out energy-driven inflation. The hike itself is small; what matters is the signal that officials would rather act early than let high energy costs push up what people expect inflation to be. More hikes are likely, but this is expected to be a short, measured cycle, not a repeat of 2022. For investors, that means higher yields on cash and short-term bonds, more pressure on long-term bonds and stock valuations, and more market swings around each inflation report. Where this cycle goes depends mostly on oil. If energy prices ease and core inflation holds steady, the Fed can stop soon. If energy costs keep spreading into other prices, rates stay higher for longer.
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