Federal Reserve Shouldn't Raise Interest Rates

After its June meeting, the Federal Reserve Open Market Committee appears poised to raise interest rates to address the inflation instigated by the war with Iran and a stronger than expected economy.

It would do better to stay on hold and let markets sort inflation, employment and growth.

Since September 2024, the Fed has lowered the overnight bank borrowing rate by 1.75 percentage points.

The federal funds target range is 1.25 percentage points lower today than it was after the September 2024 meeting, falling from 4.75%–5.00% to 3.50%–3.75%.

Just before the war with Iran, the 10-year Treasury rate, which provides a benchmark for mortgages and many other loans and bonds, 3.95%. As of this writing, it is 4.58%.

This reflects skepticism among lenders that inflation — even before gasoline and diesel prices rocketed — could go back down to the Fed’s 2% target.

Thirty-year mortgage rates are three percentage points higher than just before COVID.

To compare the 30-year mortgage rates to the 10-year Treasury— these longer-term mortgages were 6.62% just before the Ukraine war broke out, and now at 6.43%, are currently little changed.

However, just before the COVID-19 pandemic broke out in the United States, 30-year mortgages were 2.81%.

Simply, the Fed has been ineffective at lowering lower-term borrowing costs.

After recently stabilizing, fuel prices may rise further as oil in storage tanks and in transit before the war run out.

Other inflationary pressures are ever present.

Over the last year, real wages fell but retail sales have managed to outpace the Consumer Price Index.

Consumers are saving less and borrowing to buy gas but cutting back elsewhere.

At grocery stores, they are reducing purchases of snack foods and beverages and buying more store brands.

Dollar stores and fast food restaurants are gaining business, but generally consumers are spending less on an inflation-adjusted basis, for example, on groceries overall, home furnishings and health and personal care items.

To save money, lower- and middle-income households, but less so high-income households, are driving less.

In such an environment, importers, manufacturers and farmers can’t easily pass through the full impacts of tariffs, shortages of commodities made from petroleum, or other structural factors pushing up their costs.

Consequently, headline inflation surged from 2.4% in February to 4.2% in May, while inflation, less food and energy, only rose from 2.5% to 2.9%.

As fuel prices find their level, core inflation must catch up with headline consumer price index inflation for many businesses to remain solvent or achieve margins that justify their owner’s investments.

The global petroleum market will permanently change to reduce vulnerability to the Strait of Hormuz, but alternatives like new pipelines, railroads and developing other oil resources will be expensive and should keep oil prices from permanently falling back to pre-war levels.

Years of drought forced many ranchers to reduce their herds, reducing the cattle herd to a 75-year low. As a result, beef prices are likely to remain elevated, even as supplies gradually recover.

California, which produces almost half of our vegetables and over three quarters of our fruits and nuts, is enduring record heat, and roughly 60% of wheat, barley and rice farmers are in drought-stricken areas.

Extreme weather has damaged coffee supplies in Brazil and Vietnam, and El Niño will instigate additional severe weather events.

Along with tariffs, the closure of the Strait, boom in data center construction and grid modernization are boosting prices for copper, aluminum, diesel, lumber, semiconductors and electricity.

Most everything we buy requires one or several of those commodities.

President Trump’s tariffs make effective supply chain and investment planning difficult, compounding their effects on underlying inflationary pressures.

Raising interest rates wouldn’t appreciably constrain those structural forces.

The Fed can’t change the weather, Middle East geopolitics or President Trump’s trade policies.

As for lowering interest rates, the Fed had marginal success pushing down rates on short-term consumer loans.

Since September 2024, auto loan rates are down from 6.18% to 6.08% and on bank credit cards from 21.5% to 21.0%.

It would take a mighty jolt of liquidity to really move the needle on those and send folks rushing to car dealers and malls. That would cause enough inflation to impose real pain for borrowers when the Fed had to tighten again.

The labor market appears to be recovering on its own, but cheaper money could cause more rapid adoption of artificial intelligence.

The cost of investing in new AI software and supporting compute would fall relative to wages and dampen the recovery in white-collar hiring.

Monetary policy can’t much effect inevitable structural adjustments in the global economy.

Nor the breakneck pace of data center construction, because the major players in AI see building those as an existential challenge.

As my middle school band director would say, a musician gets paid just as much for resting as for playing when the score calls for it.

Fed Chair Warsh should give interest rate policy some rest.

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Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.

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