5 things to know about the Fed’s interest rate hike and how it will affect you

The Federal Reserve is raising interest rates for the third time this year, on June 15, 2022, as it seeks to counter inflation that is unfolding at the fastest pace in more than 40 years. The big question is how much this will increase rates. Prior to the latest consumer price report on June 10, most market watchers and economists were expecting a 0.5 percentage point rise. But now more are anticipating a 0.75 point increase – which would be the biggest in nearly 30 years. The risk is that higher rates could push the economy into a recession, a fear well expressed by the recent plunge in the S&P 500 stock index, which fell more than 20% from its January high, which makes it a “bear market”.

What does all this mean? We asked Brian Blank, a finance expert who studies how businesses adapt and manage economic downturns, to explain what the Fed is trying to do, if it can succeed, and what that means for you.

1. What is the Fed doing and why?

The Federal Open Market Committee, the decision-making arm of the Fed, is currently considering how much to raise its benchmark interest rate. The stakes for the US economy, consumers and businesses are high.

In recent weeks, Fed Chairman Jerome Powell has signaled that the US central bank will likely raise the rate by 0.5 percentage points to a range of 1.25% to 1.5%. But markets and Wall Street economists are now pricing in a bigger 0.75 point rise as consumer price data from May suggests inflation has been surprisingly tenacious. Some Wall Street analysts suggest a 1 percentage point hike is possible.

Since the release of the latest consumer price index data on June 10, the prospect of an accelerating pace of rate hikes has sent financial markets down 5%. Investors worry that the Fed could slow the economy too much in its fight to reduce inflation, which, if left unchecked, also poses serious problems for consumers and businesses. A recent poll found that inflation is the biggest problem Americans think the United States is currently facing.

2. What is the Fed trying to achieve?

The Federal Reserve has the dual mandate of maximizing employment while maintaining price stability.

Often, decision makers have to prioritize one or the other. When the economy is weak, inflation is usually subdued and the Fed can focus on keeping rates low to stimulate investment and boost employment. When the economy is strong, unemployment is usually quite low, allowing the Fed to focus on controlling inflation.

To do this, the Fed sets short-term interest rates, which in turn help it influence long-term rates. For example, when the Fed raises its short-term target rate, it increases borrowing costs for banks, which in turn pass those higher costs on to consumers and businesses in the form of higher rates on loans. long term for homes and cars.

Right now, the economy is quite strong, unemployment is low, and the Fed is able to focus primarily on reducing inflation. The problem is that inflation is so high, at an annualized rate of 8.6%, that bringing it down could require the highest interest rates in decades, which could significantly weaken the economy.

And so the Fed is trying to execute a so-called soft landing.

3. What is a “soft landing” and is it likely?

A soft landing refers to how the Fed attempts to slow inflation – and therefore economic growth – without causing a recession.

In order to stabilize prices without hurting jobs, the Fed is expected to raise interest rates rapidly in the coming months – and it currently expects rates to be at least 1 percentage point higher by 2023. It has already raised its key rate twice this year. by 0.75 percentage points in total.

Historically, when the Fed has had to raise rates quickly, economic downturns have been hard to avoid. Can he handle a soft landing this time? Powell insisted that his policy tools have become more effective since his last fight against inflation in the 1980s, this time sticking the landing. Many economists and other observers remain uncertain. And a recent survey of economists notes that many expect a recession from next year.

That said, the economy is still relatively strong, and I would say the odds of a recession beginning next year are still probably close to a toss-up.

4. Is there a way to tell what the Fed might do next?

Each time the Federal Open Market Committee meets, it seeks to communicate what it plans to do in the future to help financial markets know what to expect so they are not taken by surprise.

One of the pieces of future guidance the committee provides is a series of dots, with each dot representing a particular member’s interest rate expectations at different times. This “dot chart” previously indicated that the Fed will raise interest rates to 2% this year and 3% soon.

Given the inflation news since the last meeting, investors are now anticipating an even faster pace of rate hikes and expect the target rate to be above 3% by 2023. Long-term interest, such as US Treasury yields and mortgage rates, are already reflecting these rapid changes.

So investors and economists will be watching how the Fed’s dot chart moves after its rate decision is announced on June 15, which will determine how quickly committee members expect to raise interest rates. interest in the coming months.

5. What does this mean for consumers and the economy?

Interest rates represent the cost of borrowing, so when the Fed raises the target rate, money becomes more expensive to borrow.

First, banks pay more to borrow money, but they also charge individuals and businesses more interest, which is why mortgage rates rise accordingly. This is one of the reasons mortgage payments have risen so rapidly in 2022, even as housing markets and prices begin to slow.

When interest rates are higher, fewer people can afford a home and fewer businesses can afford to invest in a new factory and hire more workers. Therefore, higher interest rates can slow the growth rate of the economy as a whole, while dampening inflation.

And this is not a problem that concerns only Americans. Higher interest rates in the United States can have similar effects on the global economy, whether by increasing their borrowing costs or by increasing the value of the dollar, which makes it more expensive to buy goods. Americans.

But what that ultimately means for consumers and everyone else will depend on whether the pace of inflation slows as much and as quickly as the Fed had expected.

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