Interest rates reach 22-year high as Fed battles inflation
As America’s central bank, one of the Federal Reserve’s main roles is to set our nation’s monetary policy. By manipulating the cost and availability of credit, the Fed seeks to influence spending, employment, investment and inflation to promote the health of our economy and financial system. To be fair, the Fed didn’t create America’s high inflation. However, as part of its mandate, it bears the responsibility for trying to get it under control. Indeed, a highly unenviable task.
For the past 16 months, the Fed has been aggressively raising the fed funds rate in its attempt to help crush inflation. The fed funds rate acts as a benchmark, or beacon, for many forms of consumer debt. As the fed funds rate is either raised or lowered, so typically do the interest rates on credit cards, HELOCs, bank loans and home mortgages.
On Wednesday, at its July meeting, the Fed raised the fed funds rate another 0.25% to a range between 5.25%-5.5%, the highest rate in 22 years. Back in March 2022, the fed funds rate was near 0%. Since then, the fed funds rate has been raised 11 times. The Fed’s goal is to disincentivize consumer and business spending and thus help reduce inflationary pressures. Rising interest rates make it more expensive to borrow money to purchase goods and services on credit.
In response to the Fed’s actions, interest rates on consumer debt has soared. According to Bankrate, the national average rate on a 30-year home mortgage is 7.28%. Two years ago, the average rate was around 2.75%. Assuming a consumer buys a $225,000 home and puts down a 20% down payment, this would increase the monthly principal and interest payment by $497, or $5,964 per year. That’s a substantial burden placed on home buyers.
The average interest rate for a HELOC is 8.58%. The average interest rate on a five-year auto loan has risen to 7.24% for a new car and 8.5% for a used car. Finally, the average interest rate on credit cards is a blistering 24.24%, according to LendingTree.
With the fed funds rate now at 5.25%-5.5%, the big question is – where do interest rates go from here? That answer will rely heavily on the future path of inflation. The Fed is still predicting it will need one more 0.25% rate hike by the end of the year. This would raise the fed funds rate to between 5.5%-5.75%.
Substantial progress has been made on the fight against inflation. One year ago, inflation reached 8.9%. Today, the rate of inflation is at 3%. But remember, the ultimate goal is to return to the Fed’s target rate of just 2%.
On Wednesday, however, Fed Chair Jerome Powell reaffirmed that the fight is far from over. At his post-meeting press conference, Powell stated “Nonetheless, the process of getting inflation back down to 2% has a long way to go.” The U.S. economy hasn’t seen an inflation rate below 2% since February 2021 (1.7%).
The challenge for Powell and his Fed colleagues is that the year-long decline in inflation has been primarily driven by a decline in energy prices. If you were to remove energy prices from the inflation calculation, the inflation rate would jump from 3% to 5%. This conveys that, outside of energy prices, inflation is still quite rampant and widespread throughout the economy. Moreover, in July, crude oil prices have risen about 18%.
As the famous lawman Barney Fife used to say, “Nip it in the bud.” And that’s what the Fed is trying to do with inflation – nip it in the bud. But inflation remains stubbornly high and energy prices are now creeping higher. All this may complicate the Fed’s ability to finally put an end to raising interest rates.
Mark M. Grywacheski, Investment Advisor
Quad Cities Investment Group is a Registered Investment Adviser.
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