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- Rates are rising: why the Fed tightened monetary policy for the first time in three years
Rates are rising: why the Fed tightened monetary policy for the first time in three years
The US Federal Reserve System (FRS) has announced an increase in the interest rate on federal loan funds. The regulator has made such a decision for the first time in three years. The rate was increased by 25 basis points to 3.75–4% per annum. This move coincided with the expectations of analysts and market participants, but contradicts what US President Donald Trump is trying to achieve from the Fed. Why the regulator increased the rate, whether this will become part of the increase cycle and how it will affect the relationship between the White House and the Fed — in the "Izvestia" material.
A course for growth
The Federal Reserve raised the interest rate for the first time in three years, increasing it by 25 basis points to 3.75–4% per annum. This is reported in the press release of the regulator following the meeting on September 15-16.
The last rate increase was on July 26, 2023. Then the regulator increased it to 5.25–5.5%.
Before the meeting, the rate was in the range of 3.5–3.75%. The American central bank has left it unchanged five times in a row. At the same time, in 2024 and 2025, the Fed nevertheless eased monetary policy three times.
First of all, the decision to raise the interest rate is motivated by the desire to contain inflation. The Fed's preferred PCE price index grew by 3.7% in June and July. And in August, the situation did not get much better. The tightening of the PREP is designed to bring inflation back to the 2% target.
Additional risks have been created by an increase in the cost of oil above $100 per barrel, an increase in the US government debt to more than $40 trillion and a rise in the price of ten-year treasury bonds above 5%, which is the highest since 2007.
The regulator's decision did not come as a surprise, coinciding with the expectations of analysts and market participants. Traders, according to CME FedWatch, estimated the probability of an increase at 88%. And the most expected range was precisely 3.75–4%.
US stock indexes have already reacted to the rate increase, adding 0.1–0.7% during trading on Wednesday. At the same time, the exchange rate of the US currency in the dollar and euro pairs strengthened following the meeting, starting trading at $1.1511.
The split at the highest level
The announced increase was the first for Kevin Warsh as head of the Federal Reserve. And this decision was clearly not easy for him — after working in the post for only about four months, he found himself between two fires. Financial markets were waiting for a rate increase, while Donald Trump continued to demand a reduction.
The American leader is convinced that the United States should have the lowest cost of borrowing in the world, at 1%. In his opinion, Trump repeatedly criticized former Fed Chairman Jerome Powell for reducing rates too slowly, which eventually ended with his resignation. The Ministry of Justice even launched a criminal investigation into the testimony of the former chairman in Congress, but the case was later closed.
In an attempt to achieve what he wanted, the US president has already threatened that Washington will stop trading with some countries if the Fed does not lower the interest rate. He explained the need for such a step by striving to avoid budget deficits with other states.
Trump had high hopes for Warsh. "There is "no doubt" that he will become "one of the great Fed chairmen, perhaps the best," the head of the White House said.
Before taking office, Warsh himself assured that under his leadership the American central bank would be able to lower interest rates. And, since this has not happened, the new head of the Fed risks also coming into conflict with Trump.
However, Warsh's refusal from previous promises was significantly influenced by the fact that the economic forecast has changed since then. Energy prices have risen amid the Middle East crisis, and the development of artificial intelligence, which requires large investments, has increased inflationary pressures.
During a press conference following the meeting, the chairman of the regulator said that inflation had been "too high for too long."
"We need to be sure that core inflation is clearly and rapidly approaching our target," Warsh said, stressing that the decision was not dictated by the market.
What will happen next
It should be borne in mind that, as a rule, by changing the rate once, the world's central banks launch a cycle of increases or decreases necessary to influence inflation and economic activity.
However, under the influence of various events in the country and the world, the strategy of forming the PREP may change, including in the direction of maintaining rates. However, investors and analysts still expect the Fed to make a series of increases in the near future.
By the end of the year, experts suggest, if energy prices remain high, the rate may rise to 4-4.5%. Taking into account the Fed's September meeting, Bank of America strategists expect the total increase for 2026 to be 75 basis points. At the same time, a number of other analysts agree that the cumulative tightening will reach 50 basis points. However, JPMorgan experts do not rule out that the September increase will be the only one this year.
The actual trajectory of the US interest rate will depend on the course of the conflict in the Middle East and oil prices, as well as their impact on core inflation and inflation expectations. Only a significant reduction in quotations will allow the regulator to avoid tightening monetary policy.
Domino effect
It is important to keep in mind that any Fed rate hike triggers a chain reaction in the global economy, since the dollar, despite the trends of recent years, is still the main reserve currency.
This will be a serious trigger, for example, for Japan. The yen traditionally reacts to the Fed's actions by weakening, as Japanese capital begins to flow from local assets to American ones (after all, the Bank of Japan prefers to keep near-zero or negative interest rates). In addition, it is important to keep in mind that Japan is the largest foreign holder of U.S. Treasury bonds, which will also be important in the current situation.
At the same time, the European economy will suffer from the Fed's decision through several channels at once. The weakening of the euro will naturally lead to an outflow of capital. However, this is not the worst consequence for the EU. A much more serious threat is the risk of stagflation. For the European Union, the dollar means an increase in the price of imported liquefied natural gas and other raw materials, which will fuel inflation. But the ECB cannot raise rates after the Fed, as this may finally finish off the fragile industrial growth of Germany and Italy.
And, in addition, an increase in the debt burden may become a separate problem. In this case, southern European countries with high government debt (Italy, Greece) risk higher yields on government bonds, as the American risk-free asset becomes more attractive than the European one.
The Russian economy is much more independent of the Fed's actions. But even in her case, the channels of influence still remain. Formally, the ruble is disconnected from the dollar due to strict currency controls and settlements in national currencies. However, an indirect link persists through the discount on Russian Urals grade oil to the global Brent benchmark. And although the domestic benchmark has now slightly exceeded the Western benchmark in value, the situation may change following the geopolitical situation. In the case of a cycle of increases from the Fed in the long term, this will still have consequences for the Russian Federation.
It is also important to take into account that the global rise in the cost of money will affect the situation with the cost of external debt, making refinancing more difficult even outside the Western financial system.
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