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The Daily Tar Heel

Column: WTF (What the Federal Funds Rate)

DTH Photo Illustration. Why the federal funds rate matters to college students.

Inflation – it’s why your blue cups at He's Not are more expensive.

Your dollar is worth less, and Jerome Powell, Chair of the Federal Reserve, is tightening the market with hopes to strengthen the American dollar. I’m going to tell you what’s happening with runaway inflation, what the federal funds rate has to do with it and how to capitalize off of contractionary policy.

As of August, the United States is surviving off an insane inflation rate of 8.3 percent (comparative to the target rate of 2 percent). Most economists pin rising prices to increased demand, supply chain straits, the war in Ukraine and dislocations in the labor market.

 “The Fed’s job is to make the crisis better and clean up afterward. We saved the economy and now we are going to have to clean it up,” Dan Barkin, business journalist and adjunct professor at UNC, said. 

That’s where the federal funds rate comes in. Federal funds huh? Federal funds who?  Here’s an example:

Let’s say an athlete wanted a scooter, obviously. They’d go to the Bank of Noelle for a loan and said athlete would invest in a scooter, consequently increasing productivity in the “market”. But the Bank of Noelle doesn’t have cash on hand, so she calls the Bank of Guskiewicz to borrow some cash (or bonds, or reserves, in general). 

Note that banks regularly borrow from each other, especially when the federal funds rate is low. But, wait! Jerome Powell increased the federal funds rate for the fifth consecutive quarter! It’s now going to cost way more to give out that loan. Looks like that athlete is going to have to walk, thus, literally slowing down the market.

This is called monetary policy. It’s important to note that the Fed isn’t red or blue, but instead its own entity. Powell doesn’t get political.

Though the federal funds rate doesn’t impact people directly, it cascades into every aspect of the economy.

“The impact of interest rates are broad,” Patrick Conway, professor of economics at UNC, said. “As the Fed changes the federal funds rate, it puts upward pressure on businesses to charge more.” 

Ultimately, the federal funds rate slows down spending because it costs more to borrow money, which in turn tames inflation.

But, like first-year frat boys on a random Thursday night, inflation has proven hard to manage. That’s why you may have heard about the stock market crash on Wednesday. 

“It’s not because of something that happened, but didn’t happen. Inflation was higher than expected," Conway said. "It’s stubbornly large."

Every day feels like Sunday scaries for the S&P 500. On Sept. 13, Powell hinted at further increasing interest, and pulled the trigger with a three-quarter percent hike on Sept 20. Triple A indexes, like the S&P 500, dropped 4.07 percent in the last five days. 

In May, Powell said the three-quarter percent hike in the federal funds rate was “unusually large," but seeing the third three-quarter increase last Wednesday, it’s looking like the new normal. 

For context, from 2009 to 2013, the federal funds rate stood under one percent. The rate only saw a slight increase to around two percent in 2019, then back down to the zeros until January 2022, when rates climbed to today’s 3.0 to 3.25 percent range. 

You know that meme of the dog sitting in a house fire, claiming that his situation is "fine"?

“This is fine” dog is the epitome of our economic state. The fires of inflation are diminishing purchasing power, but still … everything is fine? The labor market is strong, as the unemployment rate sits at 3.7 percent. But, Powell is standing outside pointing a water hose at the market.

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Okay, so where should you put your money? I'm going to insensitively assume that you have $10,000 lying around. Bear with me.

After understanding the volatility of the market, you’re going to want to save. The American dollar is not relatively worth much. A smart investor would want to optimize savings by taking advantage of the rising interest rates for government debt. Buy bonds!  

First, Treasury Bonds, or T-bills. These are IOUs from the government, to which they will pay you a set interest rate every six months until they mature. The current interest rate for a 10-year Treasury Bond is around 3.7 percent — the highest since 2011. 

If you have read this far – hi, Dad – Series I Bonds will flex on your portfolio. Seriously, with a 9.62 percent interest rate, this return exceeds inflation. The Series I not only compensates for the weak dollar, but profits off of it. This is because the Series I works off both a variable and fixed interest rate. 

Both of these bonds, however, cannot be cashed in for a specific increment of time. For example, you cannot cash out on a Series I before 12 months, and if you cash it before five years, you will pay a penalty for the last three months. 

Still, get in there! If you start investing now, I pinky-promise future you will literally be indebted to you. After all, you know what they say: we are here for a long time, not a good time … when it comes to the stock market.