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Why does the Fed raise interest rates?

Why does the fed raise interest rates? Well, we know it’s to cool off inflation but this is complicated stuff when it gets down to it. Real estate agents, Boston condo buyers and sellers need to have a basic understanding of how inflation works and why the Fed does what it does. A few weeks ago I was with my good friend, who went into detail about it, which I would like to share with you in this Boston real estate blog post.

What is the Consumer Price Index?

 Consumer Price Index or CPI is a measure of inflation and deflation. Investopedia defines Consumer Price Index as the monthly change in prices paid by U.S. consumers. In August, inflation was up by 8.3%, when the number came out in September, it was 8.5%.

Every month, when a reading comes you’ll hear 0.6 or 0.7. When new numbers come out, you’ll be replacing last year’s. Last year, inflation was at its lowest point. You’re seeing 0.3 in July, 0.2 in August, and 0.3 in September. When the numbers came out in June 2022, it was significantly higher. 

August comes in and it’s even lower than last year. September was lower as well so when you’re replacing the numbers and adding a higher figure, it increases the overall inflation figure for the year over year.

Inflation and Mortgage Rates

You’ll hear economists and forecasters talk about this all year. We were up 0.6 right now if you look at October 2021. When the November reading comes out, we should see some measurable difference in inflation going down. 

Mortgage rates follow inflation. It has a history of time with the exception of Quantitative Easing. This is when the government is coming to buy mortgage-backed securities and treasuries. As the Fed stopped buying mortgage-backed securities and said they were gonna let things run off, you can see that’s when the rates started rising.

What the Fed was trying to do was to keep the rates artificially low during the pandemic. They were printing money left and right, trying to keep the economy coming to a complete halt. The Fed did a good job of what they wanted to do, but the rates should have never been at 2.5% or 3%. It’s unrealistic, especially as inflation starts to rise.

What we’ve been seeing is some of these interest rates following inflation rates are going back to where they should have been if the Fed wasn’t buying mortgage-backed securities.

Why is the Fed Raising Interest Rates?

When the Fed raises interest rates, it takes three to six months to see that impact. We’ve just gotten to that six-month mark. It’s a supply issue too. If you don’t keep going and raising rates, you might have a temporary pause and we’re going to be back to prices shooting up in every sector. 

Getting the money supply out of circulation is a reason why the Fed wants to raise the interest rates so quickly. They’re trying to reduce buying power and bring down demand. When demand comes down, prices start to come down, and that’s how they’re trying to curb inflation.

What Happens the Fed Didn’t Raise the Rates?

If the Fed didn’t raise interest rates prices would continue to go up and then would have had a hard fall. The whole reason they’re doing this is to prevent a huge recession. Chair of the Federal Reserve Jerome Powell said that we clearly don’t know whether this process will lead to a recession. They don’t understand that this is a problem, and these are the most powerful people in the world controlling the money supply.

The rates have been in the 4% range according to the majority of Max’s career. In 2018, Rates were coming up and there were two days when rates were over 5% and everyone was freaking out. 

In 2019, you’re seeing them in high threes and fours which was carried through 2020, then COVID hit and we saw everything drop substantially. Having a rate of 4%-7% is still historically low.

Today, the mortgage rates are round 7%, but they seem to be stabilizing.