- Higher-than-expected inflation in August means the Fed will likely back another giant rate hike next week.
- Rate increases have already made mortgages, car loans and credit cards much more expensive for Americans.
- Markets are now expecting bigger increases through 2023, leaving households to prepare for more economic hardship.
Since the start of 2022, it has become much more expensive to take out a mortgage, hold credit card debt, or obtain a loan of any kind.
New data suggests the wave is just beginning – and it could add even more pain in the form of job cuts and small increases.
The Federal Reserve’s fight against inflation hit a fork when the consumer price index was updated on Tuesday. Had inflation slowed more than expected in August, the central bank might have eased interest rate hikes and the economy might have avoided a growth slump.
This does not happen. Inflation has slowed, but only slightly. The year-on-year rate fell from 8.5% to 8.3%, but prices rose 0.1% in August alone, accelerating after remaining flat the previous month . Fed officials have made it clear that they will only withdraw their rate hikes once they see “irrefutable evidence” that inflation is slowing. The August report doesn’t come close to matching that description.
There is “no chance now” that the Fed will slow its turnover and raise rates by only half a percentage point, said Ian Shepherdson, chief economist at Pantheon Macroeconomics. Markets, economists and analysts see another 0.75 point rise – the third in a row – as almost certain.
Interest rates are the Fed’s best tool for slowing the rate of price growth. Higher borrowing costs tend to slow economic growth as Americans rein in spending and businesses slow down expansion plans. Demand is falling, supply is catching up, and upward price pressures are easing.
Higher rates also put more pressure on the labor market. Companies tend to limit their hiring plans and grant smaller raises when borrowing is more expensive. The drop in demand can even lead to a significant drop in income and prompt companies to cut jobs altogether.
Tuesday’s inflation release didn’t just change the math for the Fed’s September meeting. Economists are now bracing for a much more aggressive hiking cycle throughout the year, with bigger hikes and few signs of slowing down.
For the average American, this will mean expensive loans, smaller raises, and an increased risk of job loss.
The Fed’s rate hike plans have become much more aggressive
In just one week, bets on how the Fed will raise rates have soared much higher. Traders now expect a considerably more aggressive bull cycle through the end of 2022.
Market positioning last week signaled a 76% chance of a 0.5 point rise, according to data from CME Group. A narrow majority now sees officials raising rates another 0.75 points in November to a range of 3.75% to 4%.
Market bets signal that the Fed will not stop there. The CME data pegs the odds of a December half-point hike at 40%. A week ago, options positioning indicated a 75% chance that rates would rise only a quarter point at this meeting.
In short, investors are now bracing for two more 0.75 point rises and a 0.5 point rise to end the year. This will leave rates half a percentage point higher at the end of 2022 than was expected just a week ago. After weeks of hawkish language from Fed officials and a disappointing inflation report, it looks like the market is finally closing in on the central bank’s “go big or go home” outlook.
“The Fed has made it clear that it won’t take any risks, even if it increases the risk of over-tightening,” Pantheon’s Shepherdson said.
This tightening is already having an effect on American finances. Mortgage rates rose last week to their highest level since 2008, further eroding home affordability in an already tight housing market. Credit card rates have risen sharply through 2022 and increased interest payments for those with heavy debt. And since it usually takes about a year for rate hikes to be fully felt across the economy, these tightening effects will only intensify.
Fed officials have also made it clear that they want to avoid the biggest risks from monetary tightening. Powell warned in August that slowing inflation with steep rate hikes would “bring some pain” to households and businesses in the form of a less favorable labor market and more expensive loans. That discomfort will likely be worth it in the long run, he added.
“These are the unfortunate costs of reducing inflation, but a failure to restore price stability would mean far greater pain,” Powell added.