Over the years, the Federal Reserve Board has used the Discount Rate (more recently the Fed Funds Rate) to influence economic growth, raising rates to fight inflation in strong economies, and lowering them to stimulate demand in times of economic weakness. Sharp movements in prices of key aspects of consumer spending, particularly energy, can have an effect on inflation that is beyond the Fed’s control. Nevertheless, it is clear from this chart that these two key economic indicators are closely tied.
Current Comment: The relationship between the Fed Funds Rate and Y/Y consumer price inflation has remained intact during the past year. However, given a return to moderate consumer price inflation in late 2009 and early 2010 versus deflation in much of 2009 (see black line), it is likely that the Fed Funds Rate will be increased at least moderately at some time during the coming year. Any longer-term movement in interest rates from this point can only be to the upside, an obvious risk that investors in stocks and bonds must monitor carefully.
