Consumers Should Brace for ‘More Pain’ When the Fed Votes on Interest Rates This Week

The Federal Reserve will likely push interest rates higher when policymakers vote on it Wednesday, raising the cost of everything from credit card rates to mortgage loans, but all ears will be listening for any hints on what the central bank may do next.

In its ongoing crusade against inflation, the Fed is widely expected to raise its benchmark rate by a quarter point to a range of 5.25% to 5.5%. That would mark the 11th hike since March 2022, bringing the Federal Funds rate to a 22-year high.

The rate influences everything from the performance of the stock market to consumer loans. Financial products such as credit cards and home equity lines with variable rates typically follow the Fed's rate.

"A bit more pain lies on the horizon for consumers with variable rate debt —with higher rates comes higher variable rate mortgage payments," said Jeff Harris, a finance and real estate professor at American University. "Moreover, more pain lies ahead for real estate in general as higher rates put greater pressure on new financing."

Financial products analytics website WalletHub estimates that a quarter-point hike from the Fed will cost credit card users $1.72 billion over the next 12 months. Already, the Fed's hike since March 2022 are costing those holding credit card debt an additional $36 billion over the next 12 months. It's also increased the cost of the average 30-year mortgage by $11,600 over the life of the loan.

The Fed is raising the rate to tame inflation by slowing the economy, but it's a tough balancing act. Raising the rate too much could tip the economy into a recession.

So far, markets have largely been betting on no more Fed hikes this year following this week's expected bump. Any sign that the Fed may need to raise more, or any indication that it may have to keep rates at an elevated level for longer, could spook investors, but hopes are high.

“Inflation is now showing broad-based signs of deceleration,” says Morningstar chief economist Preston Caldwell, adding "that the Fed will pivot to aggressive cutting in 2024 after inflation falls.”

In June, however, the Fed signaled that its key interest rate may have to move higher to tame inflation. The Fed's latest so-called "dot-plot" projections, which reflect the views of its rate-setting Federal Open Market Committee, suggests the rate will peak at 5.5% to 5.75%.

"They’re getting close to the terminal target," said Sean Snaith, director of the University of Central Florida's Institute for Economic Forecasting. "But I don’t think the all-clear has been sounded."

A Slew of Good News

Fed officials have long described their decision-making process as data dependent, and a slew of economic data over the past month have shown their inflation fight is not only succeeding, but may even end in a soft-landing for the economy instead of a dreaded recession.

The latest reading on the Consumer Price Index showed inflation is continuing to cool. It rose 3% in June over the past 12 months, compared with 4% in May. That's considerably down from its peak in June 2022 of 9.1%, and consumers have taken notice.

Consumer sentiment jumped 13% in July, hitting a high not reached since September 2021.

Another key piece of data for the Fed's consideration was a report showing the labor market added only 209,000 jobs in June, well below below economists’ expectations of a net gain of 240,000 jobs. Though the report suggested the economy may be slowing under the weight of the Fed's rate hikes, it also showed the labor market remains resilient – perhaps hitting a sweet spot for a hoped-for soft landing. The unemployment rate fell to 3.6% from 3.7% in May.

The strong labor market, while great for the economy, could prolong the inflationary cycle.

Historically, there's been a trade-off between inflation and unemployment that hasn't emerged in the latest cycle. Low unemployment, leading to higher wages, could mean elevated levels of inflation for longer.

"Wages don’t go down," Snaith said. "They’re not going to start paying people $8 an hour."

Still, throughout all the push and pull of all the economic news, the stock market has rocked onward, up more than 18% year-to-date.

Recession or Soft Landing?

Not all the data, however, is flashing green. The Conference Board's U.S. Leading Economic Index, a predictor of the overall direction of the economy, declined in June for the 15th straight month — the longest streak of consecutive drops since the run-up to the Great Recession in 2007 and 2008. The Board forecasts a recession beginning in the current quarter of this year.

Of 41 economists recently polled by Reuters, 85% predicted a recession would hit some time this year.

Many other economists, however, say the odds of a soft landing have improved sharply over the past month. Goldman Sachs last week trimmed the probability of a coming recession to 20% from 25%.

For now, however, the economy keeps growing enough to indicate a soft landing is in store. U.S. gross domestic product grew 2% in the first quarter of 2023. The Fed, however, has said it projects full-year GDP growth of just 1% in 2023 and 1.1% in 2024.

"Like the Fed staff, we continue to look for a modest contraction to take hold toward the end of the year," J.P. Morgan chief economist Michael Feroli and his colleagues wrote in a recent report, "but the path to a non-recessionary disinflation is starting to look more plausible."