Economists like to say that interest rates make the elevator go down and the stairs go up. The metaphor underscores how quickly the Fed can reduce borrowing costs during an economic crisis and how quickly it can raise interest rates when the economy recovers.
This time around, however, rates could go up like an escalator.
Get ready for another big half-point hike in June
At the conclusion of its June 14-15 rate-setting meeting, the Federal Open Market Committee (FOMC) appeared poised to accelerate the tightening cycle with another half-point hike, the most in more than a year since officials announced rate hikes in 1994. standard quarter point.
The Fed will also update its summary of economic forecasts, which will show policymakers’ views on inflation, unemployment, growth and borrowing costs over the next two years. Embedded in those findings will be what Fed Chairman Jerome Powell and his colleagues have already hinted at: Officials will raise interest rates by a third straight half a percentage point at their next meeting in July to bring down inflation.
If all goes as expected, that means the Fed’s benchmark for interest rates will rise by 1.5 percentage points in just three months. Whether it’s mortgage interest and auto loans or fluctuating stock prices, your wallet is sure to feel it. But even then, the Fed’s benchmark will only return to 2019 levels, and the path forward is unclear.
“When interest rates are low, unemployment is low, and inflation is high, it’s easy to say bad things,” said Greg McBride, chief financial analyst at Bankrate. “But the more they raise rates, the more The harder the job is, especially if inflation remains high and we see a marked slowdown in the economy and employment.”
Here are the four biggest questions surrounding the Fed’s June meeting — and how they might affect your wallet.
1. What will the Fed do with interest rates after the June and July meetings?
While officials cleared most of the tension over the June and July rate decisions, the upcoming meeting still matters: The updated economic forecast, along with the rate decision, will be the first compilation of officials’ game plans for the remainder of the day year.
The latest iteration has set the federal funds rate in a target range of 1.75% to 2% until the end of 2022, a threshold that policymakers expect to reach in July, according to its so-called “dot plot” chart.
After that, the Fed appears to have three possible policy paths: either keep raising rates by 0.5 percentage point, move to a more traditional 25 basis point rate hike – or choose to pause the tightening cycle altogether.
The latter two look particularly unlikely after consumer prices rose at the fastest pace since December 1981 in May, up 8.6% from a year earlier, before falling slightly to 8.3% in April. The increase was fueled by a surge in natural gas prices, which hit new highs in May and June, rising to a record $4.99 a gallon on June 10, according to AAA data.
“Any hope that the Fed will be able to slow the pace of rate hikes after the June and July meetings now looks remote,” McBride said. “Inflation continues to pick up, and hopes of improvement are dashed again.”
But as always, there is a high degree of uncertainty in the economy, especially as it relates to inflation. Officials don’t have crystal balls, and policymakers have obvious blind spots. This makes it difficult to find a way forward at the moment.
Through September, there are three more consumer price index (CPI) reports and three readings of another key inflation gauge officially targeted by the Fed: the personal consumption expenditures (PCE) index.
“It’s hard to see a pause right now. We have a long way to go to get inflation down to our 2 percent target,” Fed Vice Chair Lael Brainard said in a June 2 interview with CNBC. “If we don’t see a slowdown in the monthly inflation numbers, if we don’t see some really red-hot demand ease, it’s probably quite appropriate to have another meeting and we’ll continue at the same pace.”
So far, only one Fed official has hinted at possible interest in a trading halt — Atlanta Fed President Rafael Bostic — although he also stressed that the path of his support is data-dependent.
“I want to make it clear that nothing is impossible,” Bostic said in a public appearance on May 23.
At the heart of this debate is the ultimate question: How high do interest rates need to be to cool inflation without unnecessarily slowing the economy?
Understanding this requires estimating the threshold at which interest rates stop stimulating economic growth—the so-called “neutral rate.” Even in traditional times, policymakers disagree about its place. The median estimate is 2.5%, although forecasts range from as low as 2% to as high as 3%. Some officials may want to go above neutral, while others are reluctant to go above neutral. The higher the interest rate, the more difficult the interest rate debate.
“They may have a harder time making a deal later this year,” said Vincent Reinhart, chief economist at Dreyfus and Mellon and a former Fed official. “But for now, they can agree, And they agree, because no matter how you look at the neutral rate, you agree it’s below the neutral rate right now.”
2. How much will a little-known tool increase the cost of borrowing?
Higher interest rates aren’t the only way officials have removed stimulus from the economy. The Fed is also shrinking its balance sheet — a process that officially began on June 1, although the first securities won’t mature until June 15.
Officials agreed on the pace at their May meeting: From June to August, they will write off $47.5 billion worth of assets from their books as they mature. By September, that number will grow to $95 billion. About two-thirds of these assets will be government bonds; about one-third will be mortgage-backed securities.
The Fed has no plans to sell these assets outright — but experts aren’t convinced it won’t work in the end, especially for mortgage-backed securities. That’s because 97% of the $2.7 trillion the Fed has accumulated will expire in more than 10 years. The impact on consumers of the move is far from certain.
“If inflation remains high and the economy is overheating, then if the Fed sells bonds, mortgage rates will continue to rise,” McBride said. “But if they don’t sell bonds in this context, mortgage rates will probably go up anyway. And when inflation peaks, the economy slows, and the Fed starts selling bonds, the impact and magnitude is less certain.”
3. From volatile markets to now recession fears, is it too late for the Fed to act?
With the continued expansion of the world’s largest economy threatened, the Fed’s balance sheet and rate hike plan will be critical.
Fed officials hope they can moderately put the economy on the runway. Thanks to strong consumption, near-record job openings and continued job creation, policymakers hope the economy has enough dynamism to let the air out of the balloon.
But higher interest rates can discourage companies from investing. Some may even start cutting projects or people. Companies from Netflix and Robinhood to Peloton and Carvana are already slashing jobs in 2022.
“The Fed’s hikes and tighter conditions have made investing a more difficult decision,” said Eric Melis, managing director of global markets at Citizens Bank. “When you have money, you can make some bad decisions, but when your mistakes start costing you, you tend not to make as many decisions. Lack of investment leads to a lack of jobs.”
Even without job losses, slowing demand and sluggish consumption could weigh on job vacancies, wiping out the factors that give job seekers incredible bargaining power at a time when the available labor force almost outstrips vacancies by two to one.
All of this suggests that as pessimism over the U.S. economy heats up, climbing the escalator has proven difficult. J.P. Chief Executive Jamie Dimon said J.P. Morgan warned on June 1 that an economic “hurricane” was coming, whether it was “a mini-storm or superstorm Sandy,” people know. The S&P 500 is down 13% so far this year and briefly touched bear market territory in mid-May.
That’s not to say there’s no need to raise interest rates with inflation at 40-year highs — it’s about whether the Fed should have begun tapering stimulus earlier once it has momentum. In 2021, for example, a massive tax stimulus has sent the economy into a sugar boom.
“They waded in when they were supposed to put a cannonball deep in the pool,” McBride said. “There are several possible outcomes, only one of which is really good and arguably the least likely. The likely outcome — that’s a soft landing.”
Cooling inflation is even harder when supply chain shortages, overseas COVID-19 lockdowns and conflict in Russia remain to blame. Still, inflation is currently more than three times the Fed’s target.
“It’s not easy,” Powell said at the Fed’s May news conference. “Of course, it could also depend on events beyond our control. But our job is to use our tools to work towards that, and that’s what we’re going to do.”
4. What will the Fed do if unemployment starts to rise?
Cleveland Fed President Loretta Mester said Fed officials must show “steadfastness” to get inflation back on target, even if it means rising unemployment, dragging down economic growth and scaring off investors.
“If financial conditions tighten further, financial markets could remain very volatile, with growth likely to be slightly higher than expected in some quarters and unemployment likely to be temporarily higher than its long-term growth rate,” she told a business conference on June 2. level of expectations.” It will be painful, but so will high inflation. ”
Those issues could mean the economy is on a “soft” landing, not a soft one — but either outcome could hurt Americans’ wallets. In today’s environment of rising interest rates, it’s important to make sure you’re storing your money in the best possible way (the highest-yielding savings accounts on the market currently pay more than 10 times the national average) and keep paying down your debt.
If the Fed manages to stabilize inflation and “get close to full employment without too much disruption, then it’s a success,” Citizens Bank’s Melis said. “But it won’t be a soft landing for people who lose their jobs as a result.”
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