Numerous relief packages were invaluable in helping the U.S. ride out the pandemic's economic roller coaster. But today, the consequences surface every time you visit the grocery store, gas station or pay for just about anything.
Surging inflation is as much a condition of too much money chasing too few goods as it is of supply chain issues complicated by port and distribution challenges.
The Federal Reserve, however, can't wait for your backordered refrigerator to arrive before it starts to act.
"The medicine for inflation is for the Fed to raise interest rates, and you can't put enough sugar in that spoon to make that medicine taste better," said Steve Wyett, chief investment strategist for BOK Financial®. "It's always a lot harder to pull back on stimulus, whether it's monetary or fiscal, than it is to give it out."
Monetary stimulus is provided by the Federal Reserve, which ensured cash kept flowing through the economy at the pandemic's onset by slashing its key interest rate to 0% and enacting a number of bond-buying initiatives. Fiscal stimulus is approved by Congress, which pumped trillions worth of relief packages into the economy in 2020-21.
Since elected officials in Washington, DC, struggle to agree on much of anything—but especially on the tax hikes or spending cuts required to pull back the fiscal boost—the Fed must shoulder the bulk of the attack on inflation with its monetary policy maneuvers.
"It doesn't happen overnight, and it's not always neat and clean, but it's a big part of what the Fed has to do as it works to fulfill its obligation to control inflation," Wyett said.
Borrowing costs on the rise
The Fed expects to wrap up its bond-buying efforts in March. In mid-2021, it quietly allowed some specific bond market support programs to expire.
That leaves its key lending rate, which still sits at 0%, but market analysts expect the central bank to start hiking in March and continue into 2023.
"The Fed must raise interest rates because it will contribute to reduced demand for all of those goods we've been buying, and that will slow economic growth, which will allow supply to catch up with demand," Wyett explained.
Higher interest rates mean higher borrowing costs. Wyett stresses that the Fed's reaction to inflation can have as much impact on your household budget as the higher prices themselves. He urges that you allow for the ripple effects, especially in:
- Adjustable-rate mortgages. If your mortgage rate isn't fixed, find out what index your rate is based on, the spread over that index you're charged and the repricing date. Do that soon, Wyett says, as a potentially significant change is looming and you need to prepare.
- Credit cards. Since most issuers adjust their prime rate, which serves as the foundation for credit card rates, within hours of a Fed rate hike, the cost to carry a balance is heading higher.
- Any other adjustable-rate debt. Home equity lines of credit and select auto loans with variable interest rates will soon take a bigger bite out of your income.
"We're seeing the flip side of an activist Fed that lowered rates to try and increase demand and activity," Wyett said. "Now they've got to reduce that monetary accommodation and economic demand."
Inflation outlook softening
A secondary goal of Fed policymakers is to alleviate concerns that inflation will keep lurching uncontrollably higher into the future.
"Sometimes, those fears that inflation is going to be higher for the long-term can turn into a self-fulfilling prophecy," Wyett said. "So, it's okay if the Fed raises interest rates because if it didn't, many would lose confidence in the Fed, and that would be a very bad sign."
According to the latest Survey of Consumer Expectations from the Federal Reserve Bank of New York, consumers largely consider current pricing trends unsustainable. Despite a consensus that home prices would continue to soar in the coming year, the report showed a decline in inflation expectations on a short- and medium-term basis.
More specifically, those polled believed the growth rates on prices for food, rent, gasoline and medical care would fall—albeit modestly—while wage gain growth rates would flatten by January 2023.
"The Fed does need to raise rates—it's the prudent thing to do as we shouldn't have 0% interest rates with unemployment at 4% and inflation at 7%," Wyett said. "Reducing inflation means we have a slower economy, reduced demand and reduced consumer income, and we must achieve those things because we cannot continue to pay higher and higher prices."