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Let's assume the Federal Reserve knows what it's doing.
The central bank is slowing the economy with a series of painful interest rate increases. Its goal: Reduce the current 8.3% year-over-year rise in consumer prices, bringing them down to the Fed’s 2% target.
With five such interest rate hikes under our belt this year, many of us may wonder: What's next?
Brace for another year of high interest rates — and prices
Most analysts agree — and Fed Chair Jerome Powell has said as much — interest rate increases still have a long way to go. Short-term rates are currently around 3% and the Fed is targeting 4% to 4.5%, so additional rate hikes will likely continue through early 2023.
"While higher interest rates, slower growth and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses," Powell said at an economic policy symposium on Aug. 26. "These are the unfortunate costs of reducing inflation."
So when does it get better?
Here's how things are expected to go as we wash inflation out of the economy:
Through the end of 2022
Look for two more interest rate hikes by the Fed, in November and December.
That means the cost of money for home purchases and refinances is likely to get more expensive until inflation eases. While current 30-year mortgage rates of around 6% are below the half-century average of nearly 8%, we're not likely to see a turn much lower over the next 12 to 18 months.
You'll also continue to see higher interest fees for carrying a balance on your credit card.
There's likely to be another interest rate increase next year — and at that point, the Fed may stand pat, seeing how the tighter money supply impacts the economy and, most importantly, consumer prices.
Following an extended period of solid job growth as the pandemic wanes, employment will soften. There are likely to be layoffs and corporate cutbacks. There will be less talk about "the great resignation" or "quiet quitting."
A growing number of analysts believe the impending economic slowdown may be enough to tip the U.S. into recession.
One significant voice in the crowd sounding a recession alarm is Doug Duncan, chief economist for Fannie Mae, a government-sponsored company that fuels financing for the home mortgage market. He expects a "moderate recession beginning in the first quarter of 2023."
A September CNBC survey of analysts, economists and fund managers reveals that most believe that by 2024 inflation will have sunk close to the Fed's 2% target.
If so, we'll enjoy lower prices for groceries, consumer goods and the general cost of living. However, we'll also likely experience higher unemployment and a sputtering economy.
Once the Fed reaches its 2% inflation goal, it will begin lowering interest rates to restimulate the economy.
Yes, lower rates.
It's like driving your car into the middle of the desert until you run out of gas — and then hoping to find a gas (or electric) station to fuel up and restart the engine. This is how monetary policy is supposed to work.
These scenarios are based on a “just right” economic reaction to the Fed's interest rate action. Of course, as our pandemic times prove: There are plenty of unknowns that can spoil the best-laid plans.
What could go wrong? The Fed might stall the economy with higher interest rates but consumer costs might be stuck as well — not moving lower at all. It's called stagflation.
In other words, the Fed's Powell would be looking to thumb a ride to his next stop.
What does this mean for your financial decisions?
We don't live our lives according to a macroeconomic plan. We fall in love, have babies, buy houses and get new jobs, all at the whim of unknown forces. So the Fed will do its thing — and you should do yours.
Trying to make financial decisions under optimal circumstances is a ticket to Misery Bay, Michigan. What you can do is:
Don't make an iffy financial situation worse, such as by taking on too much debt.
Remember that improving your financial status is an ongoing and lifelong process. Small steps yield long-term results.
Understand that a good idea today will be a good idea tomorrow. Rush decisions are often made under false deadlines.