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The Federal Reserve raised the federal funds rate by 50 basis points on Wednesday — a reprieve from several other higher rate hikes in 2022. You know the bar is set low when you call a rate increase of 50 basis points a reprieve, but that’s what seven Fed rate hikes in one year will do to a country.
In its quest to tame inflation, the Federal Reserve previously raised the federal funds rate by 75 basis points four times in 2022 following two smaller hikes. Increasing the fed rate ultimately makes credit more expensive for consumers and businesses, and it's one of the only tools the Fed has to fight inflation.
The final increase for the year arrived on Wednesday, and it mirrors the increase in May. The current fed rate now sits at a range of 4.25%-4.50%.
“Our focus is not on short-term moves, but persistent moves,” said Federal Reserve Chairman Jerome Powell in a press conference following the rate hike. “We’re not at a sufficiently restrictive policy stance yet, which is why we say that we would expect that ongoing hikes would be appropriate.”
The markets all dropped sharply following the Fed’s announcement.
Before 2022, there hadn’t been a single 75-basis-point increase since 1994, let alone three in one year. But rates have been this high, and even higher, many times before — most recently from 2005 through 2007. Indeed, rates were 4% or greater for most of the 1990s through 2001, and were near 20% in early 1980.
Are the rate increases working?
The Fed uses rate increases to slow down economic growth, which makes it more expensive for consumers and businesses to take on credit. That deters consumers and businesses from spending, reducing demand for goods and services and, therefore, prices.
It’s not yet clear whether the Fed’s interest rate lever is succeeding in tempering inflation. But there are indicators that in some areas, though not all, things are moving in the Fed’s desired direction.
The inflation rate slowed. The latest Consumer Price Index report, released Tuesday by the Bureau of Labor Statistics, shows a lower than expected rate of inflation at 7.1%. That's down from a peak of 9.1% in June. Core CPI, which excludes volatile food and energy prices, also came in below expectations. Although inflation appears to be slowing, it still remains far above the Fed’s 2% target.
The housing market is down. The buying boom of the early pandemic years — when mortgage rates were at record lows — is over, with borrowing costs reaching 20-year highs in November, data from Freddie Mac show. Existing home sales declined for the ninth consecutive month in October, according to the National Association of Realtors. But it’s also possible that mortgage rates have peaked.
Consumers will be paying more to repay debt. Higher interest rates mean any debt you take on now and in the new year will be more expensive than it would have been a year ago. That includes new and variable rate loans like mortgages, auto, personal, as well as credit card debt. Having more expensive existing debt will likely carve into consumers’ excess savings and could deter them from spending.
Consumer spending has slowed, but not enough. Despite higher prices on goods and services, consumers haven’t cut back on spending significantly, largely due to higher wages, according to the U.S. Bureau of Economic Analysis.
“Everyone is very pessimistic about the economy except when they're at the cashier,” says Mike Konczal, director of Roosevelt Institute’s macroeconomic analysis team. “They're still buying a lot in a way that seems we still have some pretty robust growth even as we see inflation start to slow.”
But high spending isn’t the only factor at play. Konczal says that many have overlooked supply issues as well.
Employment strength persists. When you slow down demand, it also often means people lose their jobs and wage growth slows, but neither of those have happened yet. In fact, the U.S. jobs market is doing phenomenal: The economy added more jobs than expected in November and key indicators — the labor force participation rate, quit rate and job openings — have remained steady. Layoffs have already touched certain job sectors, including tech and media, but they’re not yet widespread. The Fed would prefer to see unemployment higher than its current 3.7% rate and has predicted unemployment will reach 4.4% in 2023.
“The biggest thing that's characterized the economy this year is a very strong labor market with very high nominal wage growth, very high job market growth, and very high amounts of job to job transitions,” Konczal says.
Will the Fed keep raising rates in 2023?
The Fed signaled on Wednesday that it will continue to raise its federal funds rate in 2023 and reinforced its commitment to an inflation rate target of 2%.
“We have covered a lot of ground, and the full effects of our rapid tightening so far are yet to be felt. Even so, we have more work to do,” Powell, the Fed chair, said in the press conference on Wednesday.
The Fed’s projection for its target rate in 2023 is now 5.1%. It’s unclear how quickly the Fed would act to raise rates to that level, but Powell said in the press conference that speed was no longer the priority.
How high future interest rate hikes go will depend on overall financial conditions and how fast inflation falls. There are still global inflationary factors that the Fed doesn’t control, including supply chain bottlenecks and geopolitical turbulence. And at home, high wages and low unemployment seem to be flying in the face of the Fed’s efforts.
“I think there's room for inflation to come down without unemployment going up very much or at all,” Konczal says. “Will it come down enough for the Fed to be happy is a big open question, and how much patience will [the Fed] have if it does come down, but not all the way?”
Economists are torn as to what exactly lies ahead for the U.S. economy in 2023. But if 2021’s predictions about 2022 showed us anything, it was that economic forecasting is fallible.
“Wall Street, banks, professional forecasters all kind of missed high inflation, and I think this year people expected it to be narrow in terms of what it was impacting and come back a little bit quicker,” says Konczal.
At this point, it’s anyone’s guess as to whether we’ll eke out a soft landing, enter into a mild, short-term recession, or get caught up in a full-blown global recession, as the investment management company BlackRock has recently predicted.