Fed’s Daly sees rates rising at least another percentage point as "pausing is off the table"

Key Takeaways:

• According to research, San Francisco Fed President Daly's most recent estimate places the benchmark overnight lending rate around 5%.
• She believes the Fed will be able to assess the impact of its rate hikes before moving higher, but that time is not now.
• "Right now, pausing is out of the question. It's not even brought up in the conversation "Daly stated.

San Francisco Federal Reserve President Mary Daly said Wednesday that the central bank will likely raise interest rates by another percentage point, if not more, before pausing to assess how the inflation fight is going. 

In a live interview with CNBC, Daly stated that her most current estimate in the Fed's summary of economic prospects places the benchmark overnight lending rate around 5%. She went on to say that the correct range is probably between 4.75% and 5.25%, up from the present planned range of 3.75%-4%.

"I still think of that as a reasonable landing place for us before we hold, and the holding part is really essential," she said on "Squawk on the Street" with Steve Liesman. "It's a hold-to-raise technique."

The Federal Reserve has raised the fed funds rate, which affects a variety of consumer lending products, six times so far, including four consecutive 0.75 percentage point increases.

Looking ahead, market pricing is basically consistent with Daly's prediction. Traders believe the central bank will raise another 0.5 percentage point when it meets again in mid-December, then move somewhat higher before settling around the 4.75%-5% area.

Daly believes the Fed will be able to assess the impact of its rate hikes before moving higher, but that time is not now.

"Right now, pausing is out of the question. It's not even brought up in the conversation "She stated. "Right now, the debate is rightly focused on reducing the pace and... focusing our attention truly on what level of interest rates will end up being adequately restrictive." 

The Fed is using interest rate rises as its principal tool to combat inflation, which is still around its highest level in more than 40 years.

The news has become slightly better in the last week: the consumer price index rose 0.4% less than projected in October, while the producer price index gained only 0.2%. Both price indexes are off their highs, with annual rates of 7.7% and 8%, respectively, but remain substantially above the Fed's 2% target.

Daly described the slowing of core goods inflation as "great news," and she is pleased by the overall slowing of the economy.

"Consumers are taking a step back, changing how they allocate spending," she said. "Of course, they're dealing with high inflation, so they have to make trade-offs, put things back that they would otherwise get, but they're also preparing for a slower economy." "That's a great start."

Nonetheless, retail sales grew a slightly better-than-expected 1.3% in October, according to figures released Wednesday. According to the Atlanta Fed, preliminary figures show that GDP will grow at a 4% annual rate in the fourth quarter.

Daly believes increased interest rates will continue to have an influence on the economy and bring inflation back into line. 

"When we raise it and hold it, monetary policy tightens over time as inflation falls, so that's another issue we'll have to consider," she said.

Daly went on to say that her goal is to reduce inflation "as efficiently and sensitively as we can."

What The Federal Funds Rate Holds? 

The federal funds rate is one of the Federal Reserve's primary tools for steering monetary policy in the United States. It affects everything from the annual percentage yields (APYs) on savings accounts to the interest rate you pay on credit card balances, implying that the fed funds rate effectively sets the cost of money in the US economy.

The Federal Open Markets Committee (FOMC) establishes the federal funds rate, also known as the federal funds target rate or the fed funds rate, to guide overnight lending by US banks. It is defined as a range with an upper and lower boundary.

Presently, the federal funds rate ranges from 3.75% to 4%.

This is how it works: Clients make deposits at banks, and those deposits give banks with the capital they need to make loans and other forms of credit available to their customers. Banks and other depository institutions are required by regulators to hold a specified percentage of their total capital in reserve in order to ensure their stability and solvency.

Bank capital fluctuates on a daily basis as deposits are added and withdrawn, and loans are approved and repaid. As a result, their reserve requirements are continually shifting. 

Banks frequently need to borrow money overnight from other financial institutions in order to meet regulators' reserve requirements—or they may end up having extra reserve capital to lend to their peers. The federal funds rate acts as a reference point for institutions when borrowing or lending reserves.

Monetary Policy and the Federal Funds Rate

Congress has given the Federal Reserve two jobs, known colloquially as its "dual mandate": maintain stable prices across the economy (a.k.a. keep inflation under control) and promote maximum employment. Furthermore, it is projected to contribute to the maintenance of reasonable long-term interest rates and a healthy financial system.

Fed funds are an important instrument for the central bank in managing the supply of money in the economy. This is due to the fact that it influences what banks charge each other, which in turn influences the rates they charge you and their other clients.

Consider the prime rate, which serves as a standard for consumer and corporate lending. The prime rate closely tracks changes in the fed funds rate because banks pass on the shifting costs of meeting reserve requirements.

When the Fed raises the fed funds rate, it intends to raise the cost of short-term borrowing across the economy. This, in turn, limits the supply of credit and raises the cost of loans for everyone. Limiting the quantity of money circulating through the economy can help to control growing inflation.

Reduced interest rates have the opposite impact. It lowers short-term interest rates throughout the economy, increasing the supply of money and making credit more affordable.

The Effects of the Fed Funds Rate on the current Economy

However, the federal funds rate has an impact on more than just interest rates. Its effects can be felt across the economy. 

Expectations for changes in the federal funds rate in the coming months and years are a crucial influence in the movement of Treasury yields, which are used to price many other types of business, government, and mortgage-backed credit.

Changes in the federal funds rate are also very important to the stock market. When the Fed lowers interest rates, for example, stock markets normally rise because borrowing costs for public companies should reduce, making it cheaper to expand their businesses and increase earnings.

2022 Fed Rate Hikes: Inflation

It's straightforward to forget that the Fed kept the federal funds rate around zero until the first quarter of 2022. The Fed was also continuing to purchase billions of dollars in bonds each month to stimulate the economy. All of this despite four-decade highs in different metrics of US inflation. 

When the Fed determined it was time to act on inflation, it moved quickly, raising the fed funds rate by three percentage points in just six months. The goal is to reduce high inflation rates that are eroding Americans' purchasing power without triggering a recession.