Where Are Interest Rates Heading And What Should You Do?
Two weeks ago, Jerome Powell, chair of the Federal Reserve, announced a quarter point increase in the fed funds rate. This is the first tightening of interest rates after years of incredibly accommodative monetary policy
Concurrently, the Fed has announced that it is halting its bond buying or "quantitative easing" and pursuing a sale of bonds that the Fed holds on its balance sheet, so we are also moving to "quantitative tightening." It is about time.
Extremely accommodative monetary policy, coupled with unprecedented fiscal stimulus, have resulted in the highest rate of inflation in 40 years. High inflation is a tax on the American people that affects all, from higher energy prices to higher food prices, higher used and new car prices, et al.
We were told last year that inflation was transitory and temporary, which was not true. Now, we have inflation in the 7% range and additional inflation pressures from the war in Ukraine, the sanctions on Russia for starting the war, wage pressures from employees who have leverage for salary or wage increases since there are 11 million plus job openings, just to mention a few. The Fed is late to the party in terms of fighting inflation but, at least, is beginning the fight.
What was announced was seven rate increases this year, which would put the fed funds rate near 2% at the end of the year. Further, they said they would raise rates four more times in 2023, resulting in a 2.8% fed funds rate at the end of that year. Almost a week later, Powell announced that the Fed would consider half point increases "at a meeting or meetings."
He is sounding more and more aggressive and perhaps a born-again inflation fighter now that he has been extended as Fed chair. It is unusual for the Fed to communicate its plans so clearly, and the main problem with the plan is that with inflation where it is, those rate increases mean we will have negative interest rates for a couple more years.
What the Fed is doing is trying to thread the needle between fighting inflation and not causing a recession and, instead, having a soft landing for the economy.
I am old enough to remember the last time we had inflation this high and frankly, higher. It was not a good time, and Paul Volcker (the Fed chair at the time) finally solved the problem by allowing market rates to float freely, rising to levels above the rate of inflation and causing a difficult recession. It was not good for the country and I hope we are not headed for the same type of scenario presently.
My concern is that while rates are rising, they are not currently projected to rise as quickly as they should to fight inflation. That means we will still have accommodative monetary policy, and that does not solve inflation. Additionally, just this week President Biden announced his budget for 2023. Among other things, it said that it was reducing the deficit, but still anticipated fiscal deficits in the trillion dollar range, resulting in more debt. Sounds like a recipe for stimulus to me, not exactly inflation fighting.
As a result of the foregoing, if the Fed is really going to fight inflation, I would not be surprised if interest rates were actually higher than projected and raised sooner than projected. That is not good for the consumer but probably what is needed to control inflation.
So what should you do? On a positive note, if you have a fixed-rate mortgage, you should celebrate. You are benefiting from negative interest rates, and that fixed rate cannot be changed. For instance, if you have a mortgage at 3%, your real rate of interest is a negative 4%. If you have a floating rate mortgage, lock into a fixed rate mortgage as quickly as you can as I see rates rising for quite a while.
On the rest of your debt, pay it down as much as possible. Rank any debt you have from highest rate to lowest rate and pay off the highest rate first. For most of us, credit card debt is the highest rate. According to the Wall Street Journal, the average credit card rate is 16.34%. See if you can find one of those promotions for another at 0% interest for an introductory period so you can pay down debt at no interest rate.
Further, do a budget. Yes, I know that is boring and pedantic. That said, it disciplines you to see where you are spending your money and where you can cut corners and put the additional cash against debt. Yes, I am well aware we have inflation but not paying down variable rate debt can result in more serious problems.
This is why inflation is insidious. For many of us who struggle financially, it is particularly difficult. Paying down debt and locking in fixed rates is the best way to avoid future pain.
Jeff MacLellan is retired from Landmark Bank. He spent 37 years in banking and has been tracking local economic indicators since he came to Columbia in 1987.
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