What the Fed Pause Means for Your Money
As widely expected, after ten consecutive interest rate hikes over the past 15 months, the Federal Reserve took a time out, and paused in its process to bring down inflation. Their rationale was that it takes a while for higher rates to filter through the economy and the central bank is trying to strike a balance between bringing down prices, without tipping the economy into a recession, which is often referred to as a “soft landing”.
Despite starting the current rate hike campaign later than most economists thought was necessary (the Fed’s first increase occurred in March 2022, while inflation was building momentum as early as spring 2021), there has been progress on bringing down prices. The Consumer Price Index peaked at 9.1 percent in June 2022 and now stands at 4 percent, still about twice the level that fed officials would like. Importantly, the reduction in CPI has come without a recession or widespread layoffs.
Still, if you thought that the Fed was done with the most aggressive rate hike campaign since the early 1980s, their not-so-subtle response is: not so fast. As Federal Reserve Vice Chair Philip Jefferson noted in a speech that occurred two weeks prior to the June Fed meeting, “A decision to hold our policy rate constant at a coming meeting should not be interpreted to mean that we have reached the peak rate for this cycle. Indeed, skipping a rate hike at a coming meeting would allow the Committee to see more data before making decisions about the extent of additional policy firming.”
Jefferson and other Fed officials had primed the media pump to expect the pause, but to also allow for the possibility that further rate hikes could occur before the end of the year. In the Fed’s economic projections, which accompanied the June decision, the majority of officials projected that another half of a percentage point of hiking would be necessary in 2023, which would push up the fed funds rate to 5.6 percent. Chair Jay Powell noted in his recent press conference, that inflation “has not so far reacted much to our existing rate hikes, so we’re going to have to keep at it”.
What does this mean to you and your money? Whether or not the Fed holds rates at this level, goes for another quarter, or half of a percentage point, the message is clear: short-term interest rates will remain at high levels for the remainder of 2023. That means that anyone who is carrying debt, especially debt that is tied to short term interest rates (credit cards, home equity lines of credit, variable rate business loans), should try to aggressively pay down balances as quickly as possible. For those seeking to purchase a house with borrowed money, you may want to consider an adjustable-rate mortgage, which would push down monthly payments for a fixed time horizon (7-10 years). These loans can be attractive during periods of high interest rates, but they require borrower vigilance: you are hoping to refinance the note, to a lower fixed rate, before the period concludes.
For savers, higher interest rates mean that a quick search for better rates on savings, checking, money market accounts and certificates of deposit should yield great results. After the spring banking failures, be sure that wherever you park money, you keep the balance under $250,000 so that either FDIC or SIPC insurance protects you against institutional collapse. And for investors, the message is clear: don’t stray from your diversified portfolio and attempt to guess the Fed’s next move, those projections are penciled in, because even officials don’t really know what’s next.