The Federal Reserve’s busiest year for rate hikes since Jimmy Carter was president may be coming to an end — but U.S. central bankers’ rate increases are far from over.
The Federal Open Market Committee (FOMC) is projected to raise interest rates by half a percentage point when it gathers for its final meeting of the year on Dec. 13-14. That decision will cap the year off with seven straight increases worth a whopping 4.25 percentage points, moves the Fed made in just nine months — a pace unheard of since its last inflation fight in the 1980s.
Consumers are sure to recognize it’s a smaller move than the 0.75-point increase the Fed has stuck with for four straight meetings, but experts say it signals more about the U.S. central bank’s journey than its destination.
Monetary policymakers feel they can increase borrowing costs in smaller increments now that policy is quickly approaching a level thought to slam the brakes on the U.S. economy. They’re still, however, expected to back ongoing increases to their benchmark federal funds rate that influences how much you earn when you save and how much you pay to borrow.
Likely to be the biggest news from the Fed’s December gathering, those plans might include another full percentage point worth of rate hikes and a bias to keep them there indefinitely — at least until inflation settles back down.
“Interest rates will peak in 2023, but that doesn’t mean they’ll come down in any meaningful way either,” says Greg McBride, CFA, Bankrate’s chief financial analyst. “This was a year where rates were climbing very rapidly, and next year is going to be a year where rates level off — but they’re going to level out at a higher altitude than where they are right now.”
Here’s what you need to know about the Fed’s December meeting, including where it could take interest rates into next year and what officials could say about the U.S. economy’s future heading into a likely rocky new year.
Here is what to know about the Fed’s December meeting:
1. The Fed is ready to start hiking rates in smaller increments — for now
Fed Chair Jerome Powell cemented the odds of a smaller half-point increase this month during his final public appearance before the December gathering.
“It makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down,” Powell said at a Brookings Institution event on Nov. 30.
Those remarks came a week after records of the Fed’s November meeting showed a “substantial majority” of Fed officials thought a slowdown in the pace of rate increases would “soon” be appropriate. Investors have taken heed of the message: Almost 80 percent of market participants are betting the Fed will follow through, according to CME Group’s FedWatch tool.
Powell said in November the Fed is ready to back off for “risk management” purposes. The rapid slowdown in the housing market, coupled with a rapid tightening of financial conditions, illustrates just how much its massive, rapid rate hikes have hit rate-sensitive sectors of the economy.
Now, all officials need to do is get to a restrictive stance and wait for good news on the inflation front.
“Monetary policy works with long and variable lags,” Powell said. “If you’re waiting for actual evidence that inflation is coming down, it’s very difficult not to over tighten. … We wouldn’t just raise rates and try to crash the economy and then clean up afterwards.”
The Fed is also waiting for higher rates to slow other parts of the economy — especially the red-hot labor market.
The Fed’s rate hikes have managed to take away some steam, with job openings falling to 10.3 million in October from a record high of 11.9 million in March. Yet, there are still about 1.7 job openings for every unemployed individual. The mismatch could lead to increased wage pressures that make it harder to break inflation, even as inflation in housing, goods and services cools.
Powell, in November, described a current 3.5 million shortfall of workers as a key contributing factor to today’s 40-year high inflation.
A Labor Department report showed consumer prices jumped 7.7 percent in October from a year ago, down from a 9.1 percent high in June. Meanwhile, prices excluding food and energy are up 6.3 percent from last year.
“Interest rates are restrictive, and the Fed wants to tread more lightly to reduce the risk that they cause an unnecessarily sharp slowdown of the economy,” says Bill Adams, senior vice president and chief economist at Comerica Bank. “The biggest risk on their radar is still inflation, and that’s why they’ll continue to raise interest rates.”
2. In updated projections, officials will reiterate they’re not done raising interest rates
Powell was quick to point out how the U.S. central bank isn’t ready to call it quits on raising interest rates just yet.
“Despite some promising developments, we have a long way to go in restoring price stability,” he said. “The world will be better off if we can get this over quickly.”
The December gathering will be an opportunity for Powell and Co. to inform consumers and investors how many more rate hikes are on the table. Along with this month’s rate decision, officials are set to provide new interest rate projections.
Fed officials put interest rates in a peak target range between 4.5 and 5 percent in their last guidance from September. Today, experts say it could rise anywhere between 4.75-5.25 percent — meaning the Fed’s forceful inflation fight could take interest rates back to levels not seen since the summer of 2006.
Fed officials, however, would still need to clarify whether they’ll plan to raise rates in more half-point increments or shift to smaller quarter-point moves.
“Powell has gone from this maniacal, ‘I don’t care how I break the system, I don’t care if we overshoot’ to now saying data is improving slowly,” says Dec Mullarkey, CFA, managing director of investment strategy and asset allocation at SLC Management. “They’re going to stay at that 5 percent level, and they’re going to see how the U.S. and the world, to some degree, copes with that.”
3. Powell will stress Fed’s plans to keep rates higher for longer, defying investors’ expectations
A half-point hike marks a turning point for monetary policy. After rushing to lift rates off from near-zero percent, monetary policymakers are now ready to dial back and see just how much more they have to go. But priming Fed watchers for a slowdown comes with tricky messaging. Powell will want to communicate to markets that halting rate hikes won’t immediately lead to rate cuts.
“Smaller rate hikes are not the same thing as rate cuts,” Adams says. “The bar for easing is quite high.”
Markets might not have fully digested the Fed’s plans to stick with high rates. Investors expect rates to top out at 5-5.25 percent by the summer of 2023, then retreat to 4.5-4.75 percent by December. That contrasts with a key speech from New York Fed President John Williams, who said in his final November speech before the December gathering he hasn’t penciled in rate cuts until at least 2024.
Those expectations are more than baseless hopes; experts point out that they’re guided by history. At a time when a Bankrate survey of economists puts the odds of a recession by some point in mid-2024 at 65 percent, most economists see trouble for the U.S. economy next year. The Fed has slashed interest rates to help out in an ailing economy throughout every recession — that is, except in the early ‘80s, the last time inflation became Public Enemy No. 1.
“Anytime things got tough in financial markets, the Fed came riding to the rescue. But with inflation at a 40-year high, the Fed can’t do that.”- Greg McBride CFA, Bankrate chief financial analyst
The Fed’s updated projections won’t only foreshadow how high the Fed plans to take rates but how long they plan to keep borrowing costs at that historically high level. Officials’ guidance will go through 2025.
Experts say the Fed won’t be quick to cut rates because it doesn’t want to give the U.S. economy more juice again without being sure it can declare victory against inflation. After all, pulling back too soon in the 1970s led to inflation returning with a vengeance a decade later.
“There’s a very high bar to cut because of the downside risk of a second round of inflation emerging,” Mullarkey says. “That would absolutely throttle their credibility. Investors are really tied to this notion that the Fed is going to be quick to cut rates, and the projections could be a dose of reality about the Fed’s mindset.”
4. Next year is when you could start to feel all the effects of the Fed’s rate hikes
The projections are important for more than just rate guidance: They also give Fed officials an opportunity to update consumers and investors on their expectations for the unemployment rate, inflation and economic growth in the years ahead.
Economists say it takes months, if not a full year, for rate hikes to fully filter through the economy. That means 2023 might be when consumers feel the pinch of higher rates beyond just surging homebuying costs or savings yields.
The New York Fed’s Williams also said he’s now expecting unemployment to rise to somewhere between 4.5-5 percent next year, up from an earlier forecast of near 4.5 percent. He also projects inflation could fall to between 3-3.5 percent by the end of next year.
The median forecast among officials in the Fed’s September projections put 2023’s unemployment rate at 4.4 percent. The Fed’s preferred inflation gauge was seen as falling to 2.8 percent from its current level of 6 percent, while price increases excluding food and energy were projected to hit 3.1 percent from their current 5 percent reading.
Bottom line
The bulk of the Fed’s rate hikes may now be in the rearview mirror, meaning consumers might not have to prepare for another year of mortgage rates doubling or loan rates surging by multiple percentage points. But the message is clear: High rates are here to stay, and the consequence won’t just be paying more to borrow money — but also a cooling labor market.
Prepare for heightened job insecurity by building up an emergency fund. Take advantage of the one silver lining of higher rates: increased payouts for the money you stash away in a high-yield savings account.
“It’s safe to say we’re in for a period of years where rates are higher than where we used to and inflation is higher than where we were used to,” McBride says. “The reality of it is, we’re likely to feel the pain economically before we see the gain of that lower inflation. This is where it becomes the tough part.”
