Fundamental Analysis.

[niczg]

Hay everyone.

I hope you are all well

I wanted to ask a question related to fundamental analysis.

.

Am I right in saying, if USA has an inflation rate of 5%, and its inflation target is 2%.

Then they would need to hike interest rates too get the inflation rate to its target of 2% target. Because hiking interest rates lowers the inflation rate as it reduces consumer spending as it costs more to borrow so spending will be less.

.

Would this be correct or am I getting things mixed up?

Have a great day everyone .

 

[burnout]

Yes. Actually, the US Federal Reserve needs to reduce the amount of currency in circulation to reduce inflation. If there is too much money out there then people get loose with their spending and start competing for products which drives up the prices too fast. (products flying off shelves, gasoline demand, real estate bidding wars, etc).

Increasing interest rates reduces the number/amount of bank loans, which contracts the "money multiplier" effect that loans have on the money supply, which reduces the amount of currency in circulation.

Then there is also Quantitative Tightening they do to reduce the money supply, which is simply to slow down or stop buying altogether the US gov't's debt (Treasury dept's bonds).

In the past, they also required banks to keep a minimum reserve of customer deposits set aside (10% of all deposits) and therefore couldn't be loaned out. (Loaning out customer's deposits has a "money multiplier" effect which expands the money supply.) The US Federal Reserve doesn't mandate banks keep a minimum reserve any more though (since 2020, I think). Instead, they started paying interest on any reserves that banks would voluntarily keep segregated at the Federal Reserve as an incentive to do so. A very effective change in policy, IMO. So simply raising interest rates will have an even greater effect now.

 

[1nvest]

Hay everyone.

I hope you are all well

I wanted to ask a question related to fundamental analysis.

.

Am I right in saying, if USA has an inflation rate of 5%, and its inflation target is 2%.

Then they would need to hike interest rates too get the inflation rate to its target of 2% target. Because hiking interest rates lowers the inflation rate as it reduces consumer spending as it costs more to borrow so spending will be less.

.

Would this be correct or am I getting things mixed up?

Have a great day everyone .

Hi Nic, theoretically yes.
However you also have to recognise that the US has been doing just that since April 2022. and has been raising interest rates consistently since then. Inflation in the US is currently sitting at just over 3%, down from an average high of 8% in 2022. and its forecast for next year to be in the region of 3%
So currently, had inflation just popped to 5% then yes they would be doing something about it. but given that inflation is coming down, and their fiscal policy is paying off its unlikely they will raise any more. Next week they are likely to leave rates as they are...and may even look to possibly reduce interest rates next year.
The chances of them raising interest rates again is somewhat slim, unless inflation does begin to creep up again. time will tell

 

[niczg]

Hi Nic, theoretically yes.
However you also have to recognise that the US has been doing just that since April 2022. and has been raising interest rates consistently since then. Inflation in the US is currently sitting at just over 3%, down from an average high of 8% in 2022. and its forecast for next year to be in the region of 3%
So currently, had inflation just popped to 5% then yes they would be doing something about it. but given that inflation is coming down, and their fiscal policy is paying off its unlikely they will raise any more. Next week they are likely to leave rates as they are...and may even look to possibly reduce interest rates next year.
The chances of them raising interest rates again is somewhat slim, unless inflation does begin to creep up again. time will tell

Thank you 1nvest for the explanation, it was very easy to understand now that you explained it.

 

[niczg]

Yes. Actually, the US Federal Reserve needs to reduce the amount of currency in circulation to reduce inflation. If there is too much money out there then people get loose with their spending and start competing for products which drives up the prices too fast. (products flying off shelves, gasoline demand, real estate bidding wars, etc).

Increasing interest rates reduces the number/amount of bank loans, which contracts the "money multiplier" effect that loans have on the money supply, which reduces the amount of currency in circulation.

Then there is also Quantitative Tightening they do to reduce the money supply, which is simply to slow down or stop buying altogether the US gov't's debt (Treasury dept's bonds).

In the past, they also required banks to keep a minimum reserve of customer deposits set aside (10% of all deposits) and therefore couldn't be loaned out. (Loaning out customer's deposits has a "money multiplier" effect which expands the money supply.) The US Federal Reserve doesn't mandate banks keep a minimum reserve any more though (since 2020, I think). Instead, they started paying interest on any reserves that banks would voluntarily keep segregated at the Federal Reserve as an incentive to do so. A very effective change in policy, IMO. So simply raising interest rates will have an even greater effect now.

Thank you Burnout.

Fantastic explanation Burnout.

I will definetly remember this throughout my trading journey.

 

[Zerologic]

Usually, this is the case, as recently the Fed cut interest rates because the inflation target was achieved, the central bank plays an important role in maintaining inflation, one of which is through interest rate policy. Low interest rates are also the reason gold rises.

 

["D"]

You received some nice replies.

Watch the GDP as well. Inflation, interest rates and GDP are tied together. When GDP comes in weaker the economy is not doing as well. As a result a reduction in inflation is generally expected. Central banks are not likely to hike interest rates in a contracting economy.

The Federal Reserve has two mandates. Inflation and employment. High inflation is the bad guy that has to be handled first. Right now the Fed feels they have inflation under control moving toward their 2% target. With inflation under control the Fed has turned its attention toward employment. You may want to keep this in mind as well when doing your analysis.

 

[Zerologic]

The Fed is even expected to still cut interest rates at its November meeting, as predicted by the FedWatch tool, cuts may even reach another 50 basis points. Meanwhile, US GDP is predicted to be the same as previously at 3.0%.

 

["D"]

It has been a year of extreme swings for predictions of the USD concerning interest rate cuts. Early in the year we were looking at a whole bunch of interest rate cuts in succession. Then a few months later we had dramatically different predictions of one cut in December. Fast forward a few more months and we just had the largest interest rate cut of any central bank with 50 bps, and now the predicted possibility of another 50 bps cut at the next meeting. It has been a year of rate cut predictions going from one extreme to another. We do know the cutting cycle has started for the USD. We don’t know how many cuts there will be or how deep they will be by years end. We will see what happens.

 

[Zerologic]

Some investors are even worried about the Fed cutting interest rates due to the slowdown US economy. However, this argument was refuted by Powell confirmed that the Fed's move was not a quick response to potential recession data, but rather a precautionary step to help shore up the US workforce.