The Fed’s latest rate hike: Five ways Americans might feel pain

The Fed’s latest rate hike: Five ways Americans might feel pain

Written by Lindsay (NYSE: Dunsmuir and Ann Saphir)

(Reuters) – The Federal Reserve announced on Wednesday it will raise interest rates for the third time in a row by 75 basis points in its campaign to raise borrowing costs enough to reduce high inflation in 40 years.

The goal: to get businesses and households to step back from spending and reduce demand for goods, services, and labor, thereby relieving upward pressure on prices.

But the process will not be smooth. Ordinary Americans have felt the pinch of inflation for months, and the Fed’s efforts to cut it so far have made it difficult for many consumers to buy things like a home or a car. But other shoes haven’t come down yet, like a high unemployment rate or even a recession.

Here’s how that could happen:

Unemployment is seen rising, inflation remains high

Fed Chairman Jerome Powell said the central bank’s swift and aggressive action would have “unfortunate costs” including a higher unemployment rate, which currently stands at a very low 3.7%. Federal Reserve policymakers expect it to rise to 4.4% by the end of next year, according to forecasts released on Wednesday.

Earlier this month, Fed Governor Chris Waller warned that the Fed would be comfortable with the unemployment rate rising to 5% before policy makers begin to consider any change in strategy. An increase of this degreeโ€”which could translate into more than two million job lossesโ€”has been historically consistent with an economy in recession. For perspective: In the last three recessions, the unemployment rate peaked at 14.7%, 9.5%, and 5.5% in 2020, 2009 and 2001, respectively.

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However, none of those recessions has preceded inflation anywhere close to its high today, a fact that could make the upcoming downturn even more painful.

Wage growth slows, fewer jobs

Wages grew at a 5.2% annualized rate in August, a solid segment, with the lowest paid workers seeing the biggest rise in their pay packages. But this is where the good news ends. Policy makers see the pace of wage growth as too strong for the Fed to return headline inflation to its 2% target, so they are trying to curb it. The longer these massive wage gains last, they worry, the more likely high inflation will become embedded in the economy in a self-perpetuating spiral.

One reason wage gains are so strong is the heavy demand for a pool of workers that has just regained its pre-pandemic size, even as the economy grows. The availability of roughly two jobs per job seeker reflects this, and Fed policymakers hope that companies will respond to higher interest rates mostly by cutting hiring rather than laying off workers. Fewer jobs should translate into slower wage growth, which means that unless inflation drops quickly, more workers will see their pay packages actually shrink after accounting for the damage from inflation.

Federal Reserve policymakers see inflation, at 6.3% on their preferred metric, falling to 2.8% by the end of next year, according to forecasts released on Wednesday.

Savings rates will rise, but they will also rise on consumer loans

Families will see an increase in the interest rate on their savings accounts, particularly in online establishments. But in general, banks are slow to pass on Fed rate increases to savers and do so at levels well below the central bank’s policy rate, currently inflation.

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Finance companies will also raise their rates on most consumer and auto loans, rates generally much higher than the central bank’s standard initially.

Buy affordable homes, but rents also continue to rise

Of all the sectors of the economy, the housing market is where the Fed rate hike has been hit the hardest and fastest, with mortgage rates doubling in just over eight months to the current average of 6.25% for a 30-year mortgage. general. Home sales fell. But, in part due to a severe shortage of homes, prices fell only slightly, to $389,500 for an existing home in August — still up 7.7% from just the year prior. With prices rising, monthly mortgage payments on an existing median-price home have jumped nearly 60% to $1,940 this year. Economists at Oxford Economics estimate that the number of families with income eligible for a mortgage on a median home is about 17 million fewer than at the end of last year.

Rising rental prices are also slashing incomes, providing at least a bit of relief for the next few months. The rate of increase based on the weighted average of the two major rental indices increased to 6.4% in August from last year, while the 3-month annual rate of increase jumped to 8.6% โ€œindicating that rents are still in the process of accelerating upwards. According to Ryan Wang, American economist at HSBC.

Food and gas prices: not much food can do

To the extent that the Fed raises interest rates to crush inflation, the daily prices that Americans probably care about most โ€” food and gas โ€” are beyond the reach of the central bank, the cost of which is determined by global factors that largely influence supply. Gasoline prices, which in the United States jumped more than $5 a gallon in mid-June as a result of the fallout from Russia’s invasion of Ukraine, have fallen to nearly $3.70 a gallon, the eleventh consecutive week of decline. Wholesale gasoline prices are expected to continue falling in the coming months as US refineries overproduce the fuel to try to rebuild low diesel stocks, according to analysts and traders.

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But the ongoing war in Ukraine, as well as severe drought in Europe and China, will keep food prices in the United States, already up more than 11% compared to last year, high at least early next year. Russia’s announcement earlier on Wednesday that it would send significantly more troops to Ukraine further escalates the conflict, and could jeopardize a Black Sea corridor created under a UN-backed deal that recently allowed sea grain exports from Ukraine.

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