Anyone who’s ever worked with a personal trainer knows the term “short-term pain for long-term gain.”
So it goes in economic circles this week, as the U.S. Federal Reserve is set to boost its benchmark federal funds interest rate by 0.75 percentage point.
Such a move would boost the benchmark rate to a target range of 2.25% to 2.5% as the Fed battles a rising U.S. inflation rate (9.1% through June 2022) and a souring economy.
Currently, the U.S. gross domestic product was down by 1.6% in Q1 2022, and the Atlanta Federal Reserve’s GDP Now estimate clocked in at a rate of -1.6% for Q2.
The idea is to keep raising rates to rein in inflation. That's been a favored Federal Reserve policy position for decades. When the Fed raises rates, the price of money rises, which cools the economy but can hammer already struggling U.S. households.
“The Fed has to stay aggressive with rate hikes as they know they are way behind the curve on inflation,” said Tom Graff, head of investments at Facet Wealth. “They also know that if they don't bring inflation down soon, they risk permanent damage to their reputation on maintaining price stability.”
Economic Policy Overkill?
Is the Federal Reserve taking a big risk with a hefty rate hike when so many Americans are hurting right now?
That sentiment is on the table.
“Though it’s finally showing signs of slowing down as gas and oil prices fall, high inflation remains a serious problem,” said Jacob Channel, senior economist at Lending Tree in Charlotte.
“As a result, the Fed is poised to raise its target [federal funds] rate by 75 basis points at their upcoming meeting. With that said, a 100-basis-point hike [1 percentage point] is not completely out of the question.”
What’s more, the problem with inflation is that people are spending more on the same amount of goods and services, but they’re paying more out of pocket, especially the nation’s most vulnerable citizens.
“Inflation hits the lowest-income families harder because items such as gasoline and food make up a much larger portion of their budgets, leaving less for discretionary spending,” Dan North, senior economist at trade-credit insurer Allianz Trade, told TheStreet.
For example, where people used to have money to go out to dinner, even fast food, or to the movies, once a month, now many Americans won’t do those things at all.
“Therefore, it’s the worst kind of regressive tax, taking a toll on lower-income families,” North said.
Things That Grow More Expensive With Rate Hike
As higher prices routinely track Fed rate hikes, U.S. consumers can expect wallet-busting pricing boosts in these key consumer categories.
Mortgage rates. Following what could be another large hike from the Fed, mortgage rates could trend up over the next few weeks. “Of course, there’s no guarantee that mortgage rates -- which are currently at an average of 5.54% for a 30-year fixed-rate mortgage –- will change all that drastically,” Channel told TheStreet.
Today’s rates are at a more than 10-year high.
“You’d need to go back to June 2009 in order to see the average 30-year, fixed mortgage rate at or above 5.5%,” Channel noted.
“Today’s high rates have dampened borrower demand for both mortgage purchases and refinances. In fact, demand for mortgages has just hit a 22-year low.”
Bond investments. Investors holding bonds are effectively lending money to the bond issuer, and once again the issuer pays back with a fixed amount that’s worth less with inflation.
“Since many retirees hold bonds, inflation hits their savings and their ability to spend as well, since once again they are getting a fixed payment while prices roar ahead,” North said.
Credit card rates. Consumers should pay particular attention to the annual percentage rates on their credit cards.
“Federal Reserve interest rate increases are really adding up for credit-card holders, and all signs indicate that the Fed won't be stopping anytime soon,” said Matt Schulz, chief credit card analyst at Lending Tree.
“That means even though credit card APRs are about as high as they’ve ever been, your credit card debt is only going to keep getting more expensive in the coming months.”
Home furnishings. Higher inflation leads to higher prices at retailers, too.
“Inflation snuck up on the Fed, and now we have an economy that is out of balance,” said Preston Forman, a certified financial planner with Seasons of Advice Wealth Management in New York.
“The war in Europe, loads of jobs going unfilled, and a supply chain still disrupted by the pandemic are only the most visible issues."
Forman noted that he was still waiting for a bed frame and bureau for his daughter that he'd ordered in September 2021. “We hope it arrives before she goes off to college,” he said.
Where to Go From Here?
The Federal Reserve is playing the long game with inflation, interest rates, and the U.S. economy.
“Ultimately the Fed wants a more normal inflation and rate environment,” said Forman. “When inflation is in the 3% to 4% range -- roughly the historical rate -- the Fed will likely stop.
“With the Fed raising rates at a 75-basis point clip and with some help from falling gas prices, we might get there by the end of the year,” Forman added.
