Raising its price increases the demand for US Treasury bonds

The Federal Reserve uses “interest” to clamp down on inflation

Inflation is high, interest rates are also on the rise, stock and cryptocurrency prices are falling, at a time when expectations of a possible recession are growing.

These times are the most difficult for any person, whether he saves or invests money, or intends to do so, which may make it difficult for people to invest and save options, and determines them in buying bonds away from the stock market.

important questions

But the questions posed by the current situation, especially after the US Federal Reserve took a decision to raise interest rates on the dollar, are: How do interest rates affect inflation?

Why does the Federal Reserve raise interest rates?

And how can its increase lead to facing this inflation?

How will the Federal Reserve's actions end up affecting global inflation?

These questions seem simple, but their answers may be profound, especially since the state of inflation in the United States seems somewhat bleak.

Price Index

In April 2022, for the first time in months, the annual inflation rate fell after an increase in the interest rate on the dollar.

Although the problems caused by the Corona virus pandemic began to recede, the consumer price index, which was released a few days ago, shows a rise at an annual rate of 8.3%, which is close to the fastest pace it has reached since 1981, meaning it is very high.

In addition, core inflation - which excludes groceries and gas - rose 0.6% in April from the previous month, faster than its 0.3% rise in March, which is not a good sign.

In this context, the US Federal Reserve is tightening monetary policy to fight inflation.

More precisely, it raises the short-term interest rate which it directly controls.

Inflation and Commodities

But how does inflation happen?

"Inflation happens when too much money chases too little," says The New York Times.

That is, when people have a lot of money, but there are not many goods and services to spend on them, so prices go up.

When mortgage rates rise, it becomes more expensive to buy a home. An increase in the interest rate may not reduce home inflation immediately, because the supply of homes, building materials, and workers is very limited as demand rises, which the Federal Reserve cannot do. about this lack of supply.

But with it probably resolved in a year or so, higher interest rates are likely to change the relationship between supply and demand, bringing down the inflation rate.

Supply and demand

The Columbia University economist and Nobel Prize winner in economics, Edmund S.

Phelps, that the current situation is a demand that exceeds the available supply, and this is causing prices to rise, pointing out that the “Federal Reserve” needs to “tighten the screws on demand” by raising interest rates.

Phelps warned that if interest rates were raised enough, economic growth would slow and some people would lose their jobs.

He added, "When the unemployment rate turns out to be very low, when inflation is high, the (Federal Reserve) needs to raise interest rates, but that has consequences."

soft landing

He pointed out that the economic slowdown associated with a low inflation rate may deteriorate into a complete recession, explaining that the Federal Reserve is trying to avoid this by finding a "soft landing", where growth is neither too fast nor too slow, and prices are completely correct, noting that financial markets are reacting With what the Federal Reserve does, it also interacts with what it intends to do.

In turn, the "Federal Reserve" informs the financial markets of future measures, and uses official data and publicly published economic forecasts, interviews and press conferences, to tell the markets where it wants to go.

“At the moment, it (the Fed) might scare people in the financial markets,” Professor Phelps said, noting that markets already expect that the Federal Reserve will succeed in lowering inflation expectations, and this will reduce inflation itself.

slow down spending

"By raising interest rates, (the Fed) is trying to slow spending," says Cathy Jones, chief fixed income strategist at the Schwab Center for Financial Research.

And she continued: “This happens when the cost of money rises to obtain a loan to buy a car or a mortgage or anything else you want to spend money on. It would lower inflation.

Jones saw treasury bonds as one potential savings opportunity for savers and (for two years) a reasonable option, as they currently yield 2.6%, much more than a bank account, certificate of deposit, or money market fund.

Some investment grade corporate bonds with maturities of less than five years pay more than 3.5%.

She believed that treasury bonds are currently safe and conservative options, while money markets represent more risky bets.

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