It’s not over until it’s over. That might as well be the catchphrase for the Federal Reserve’s rate-hiking war against inflation.
After leaving interest rates unchanged in June for the first time in 15 months, policymakers on the Federal Open Market Committee (FOMC) don’t appear willing to wait very long before picking back up where they left off. Officials look set on raising interest rates by another quarter point at their July 25-26 gathering, marking their eleventh total increase since March 2022.
The decision is expected to come even after investors and consumers celebrated an inflation win in June: Prices rose 3 percent from this time last year, the slowest increase since August 2021. It marks major progress from the highs of last summer when inflation soared three times faster. Adding to the positive news, annual price pressures when excluding food and energy — “core” inflation — slowed by the fastest pace since the Fed began raising interest rates.
The Fed, however, has had to lift interest rates to the highest since 2007 so far to do it — and after July’s likely increase, the upper bound of the Fed’s benchmark rate will soar to the highest level since 2001. One more rate hike is even on the table after that.
Borrowing costs on loans such as the 30-year fixed-rate mortgage and home equity lines of credit are now the highest in more than two decades, creating affordability challenges and tightening the flow of credit to households. But there have been some silver-linings: Yields at the nation’s top savings accounts are the highest in 15 years.
The process of unwinding inflation in the more-stubborn services, housing, medical care and insurance categories could take more time, and Fed officials likely aren’t yet satisfied with how high core price increases currently are. Economists say the Fed will likely want to keep its options open. Inflation could also worsen if officials give the all clear that they’re done, partially because it could spark a loosening in financial conditions that unwinds some of the necessary tightening in borrowing costs.
But that’s only if the rate-hiking spree’s end is something to celebrate. There will be no claps or cheers if the Fed reverses course because of a recession.
Yet economists are starting to feel more hopeful about the economy dodging a downturn. Inflation cooled in June, while joblessness in the month fell, Labor Department data shows. Those two factors normally have an inverse relationship. And while job growth in the month grew at the slowest pace since the coronavirus pandemic ended, employers still created enough jobs to meet population growth — and hiring is still faster than in the pre-outbreak era in 2019.
In a notable move, Goldman Sachs slashed their perceived odds of a recession in the next year to 20 percent, while the odds of a downturn even fell to the lowest level in a year in Bankrate’s quarterly forecast survey.
With a rate hike set in stone for July, the Fed will have to debate any future rate moves, including whether it’s worth speeding up the disinflationary process given the potential trade-offs of harming the job market.
Here’s three themes to watch ahead of the Fed’s July meeting, including three additional steps you can take with your money in light of the news.
1. After a likely rate hike in July, what are the Fed’s next moves?
Money tip: Rates could rise even higher after July, but even if they don’t, higher rates for longer is the Fed’s new playbook. Pay down high-cost credit card debt, and refinance variable-rate loans into fixed rates. Even historically cheaper forms of debt — such as home equity lines of credit — are now at the highest in more than two decades, Bankrate data shows.
Economists assume the Fed is laying the groundwork to hike at every other meeting this year. Officials “skipped” in June — even though Fed Chair Jerome Powell preferred not to label it as such — and signaled intentions to raise rates again by the next time they gathered in July. If they continue that pattern, they’d keep rates steady in September and raise rates again in November.
“It may make sense to move rates higher but to do so at a more moderate pace,” Powell said in June during a congressional testimony. “As you get closer to your destination, as you try to find that destination, you slow down even further.”
Economists may be starting to take the Fed’s word. The average forecast in Bankrate’s quarterly economists’ survey penciled in 5.5-5.75 percent as the peak for the federal funds rate. At the same time, 37 percent expect the Fed will raise rates once more, versus 33 percent who expected two more rate hikes.
Stubborn inflation is keeping the Fed on guard to raise rates two more times. By the end of this year, Fed officials foresee their preferred gauge of core prices hitting 3.9 percent, up from 3.6 percent. Policymakers also saw increased risks that inflation could come in hotter.
Yet, there’s always a chance prices may end up cooling even more than expected. Jordan Jackson, vice president and global market strategist at J.P. Morgan Asset Management, sees “outsized risk” that prices could get to that level even faster than the end of the year, possibly as low as 3.2 percent by the end of the year on the core measure and 2.5 percent by the middle of 2024.
On the one hand, shelter inflation is expected to level off later this year, and it’s been one of the biggest drivers of inflation. But on the other hand, the slowdown in June may have been because inflation was so high at this time last year. Whether it’s progress or simply false hope, the Fed will need more time and data to know which narrative prevails.
“The Fed is definitely going to leave all their options open, which at this point means indicating a willingness to continue to raise rates,” McBride says. “They can always skip a rate hike, but it’s tough to raise rates when they haven’t laid the groundwork for it.”
2. Inflation is still too high, but will officials be patient to let the cooldown cook?
Money tip: With the outlook uncertain, Americans will want to brace for a tougher economy ahead. For everyday people, that might mean it’ll be tougher to find a new position at best, or at worst, job losses may tick up — even if they aren’t expected to soar as high as they did during the two most recent recessions.
Officials are quick to point out that the outlook is uncertain, and projections are not commitments. Powell doesn’t even describe the Fed’s quarterly pulse on the direction of the economy as a forecast.
As always, the Fed’s next moves depend on the economy. Economists in Bankrate’s poll are split on whether inflation will reach 2 percent by the end of 2024 or the end of 2025. None expect inflation to hit 2 percent by the end of this year.
But experts are also starting to rethink just how aggressive Fed policy needs to be. Assuming the Fed follows through with its July rate hike, interest rates will be 2.75 percentage points above the level officials see as “neutral” — meaning it’s well crossed over the threshold of stimulating economic growth to restricting it.
The job market likely still needs to cool more to get inflation down to the Fed’s 2 percent goal post. Powell has indicated that wage inflation at its current levels of around 4 percent can still be inflationary. Sticky inflation in services is highly contingent on wage growth, and tighter labor markets that lead to higher pay can exacerbate those pay pressures.
But as the spread between unemployment and inflation thins, officials may need to decide: Is it better to instead raise rates more to get inflation down to 2 percent as soon as possible? Or is it worth letting inflation slow over a longer time horizon to preserve the strong job market?
“We’re now at 3 percent, and that’s down from 9 percent in an environment where we still had pretty decent, pretty strong labor market gains,” Jackson says. “It does seem that consumers have a bit of oomph to continue to spend and keep the economy afloat.”
Complicating the debate even more, if rate hikes cause a recession, it might be because the Fed has overdone it. That would lead to new risks, such as creating so much unused slack in the economy that inflation falls below 2 percent. Too-low inflation was the major economy-related concern before the coronavirus pandemic. Back in 2020, the Fed announced a change to its framework that would allow inflation to rise above 2 percent to make up for periods when inflation remained below 2 percent.
At that time, they might have been willing to stomach an inflation rate of 2.75 percent, Jackson points out. Then, inflation surged — due to factors that could’ve been blamed on the framework review, as well as factors outside the Fed’s control.
“They were willing to wait for transitory inflation to feed through just a couple of years ago, but it doesn’t seem like they’re willing to wait to get prices back down,” Jackson says. “It almost feels like the inflation ghost of the [former Fed Chair Paul] Volcker era is coming back and scaring them in their dreams in the middle of the night.”
3. The Fed’s current path for a soft landing is widening, experts say
Money tip: Markets have been celebrating the economy’s resilience, with the S&P 500 up about 19 percent since the start of the year. Still, day-to-day gyrations in markets could be possible as the Fed attempts to cool inflation without doing too much harm. But pay no mind if you’re invested for the long term and have a diversified portfolio.
The fact that inflation has fallen so aggressively without a broader dent in the economy is leading some economists to expect that the Fed may be able to achieve the impossible: A gradual cooling, or soft-landing, of the economy.
Michael Farr, CEO and founder of investment firm Farr, Miller & Washington, compares it to one of the most well-known verses in the Bible: It’s easier for a camel to go through the eye of a needle than for a rich man to get into the kingdom of heaven.
“It will be easier for a camel to pass through the eye of a needle than it will be for the Fed to engineer a soft landing,” he says. But “we could watch Jay Powell pass through the eye of a needle.”
Another tailwind in the economy’s favor, investors and consumers are feeling euphoric from the economy’s continued resilience.
The S&P 500 gained 2.5 percent in the week that headline inflation cooled to 3 percent, while consumers’ sentiment about the economy jumped to a near two-year high in a preliminary July survey from the University of Michigan. A strong job market is giving Americans the wherewithal to keep spending, while confidence about the future is incentivizing them to follow through.
“Expectations for future conditions are hugely important,” Farr says. “We’re growing weary of the recession that just won’t happen, and we’re beginning to lull ourselves into that complacent comfortable place of, ‘Well, if it hasn’t happened, then maybe it just won’t.”
Definitions, however, will be important. Some slowing is expected, but is the bar for a soft-landing only about avoiding a severe recession?
Jackson, for instance, doesn’t foresee unemployment rising higher than 5 percent, while Bankrate’s survey of economists penciled in a joblessness rate of 4.5 percent by June 2024. Both would likely signal a recession has begun — unemployment has never risen by half a percentage point without one — but that downturn would likely be milder.
“I vehemently refused that a goldilocks scenario could play out, but when I think about the dynamics over the next 12 months, it could play out if the Fed is careful here,” Jackson says. “If they’re a little more cautious, they’re able to orchestrate inflation continuing to gradually cool towards 2 percent.”
The picture was similarly looking brighter for the economy at the start of 2023 — then Silicon Valley Bank failed. Even though they’re the lowest in a year, the odds of a recession in Bankrate’s quarterly forecast are still elevated: at a 59 percent chance, indicating a downturn is the most probable outcome.
While it looks like Powell and Co. have greater odds compared with when they first began raising interest rates, the regional banking crisis illustrates that contagions can happen at any time, and the economy is impossible to predict.
“There’s always a risk; that’s just the world we live in,” McBride says. “The biggest risks tend to come out of left field. It’s possible that the Fed will avoid a recession, but I still don’t think that’s the most likely outcome.”