Borrowers' reprieve proved to be short-lived, as on Wednesday the Federal Reserve announced another increase, after skipping a June rate hike.
The decision to raise the Federal Funds rate by another 25 basis points (one-quarter of a percentage point) wasn't a surprise to financial markets, as experts were expecting the move based on Federal Open Market Committee (FOMC) members' comments during their June meeting. Still, the impact of the increase, which puts the Federal Funds rate to a range of 5.25% to 5.5%, will be felt by borrowers already reeling from the previous rate hikes.
"We've gone through one of the fastest-paced rate hiking cycles that we've ever seen—525 basis points (5.25%) in a little over a year," noted BOK Financial® Chief Investment Officer Brian Henderson.
One of the major questions looming over the Fed—and the economy—is whether we've already felt the full brunt of the previous rate hikes or, alternatively, their cumulative effect is yet to come, Henderson said.
To contend with this potential lag in effect, the Fed will likely slow the pace of rate hikes in the months to come, the FOMC's June minutes suggest. This means that, although the FOMC has meetings scheduled for September, October/November and December, the committee probably won't hike rates at each one, Henderson explained.
Inflation down to 3% but still a problem
This slower pace also will enable the Fed to get a sense of how much the turmoil that some banks experienced in March will permeate through the economy. Although the banking sector seems to have stabilized since them, the Fed wants to see if banks tighten their lending standards further, which would make it more difficult for consumers and businesses to get loans, Henderson continued.
Despite these concerns and the fact that overall inflation has been trending downward to a year-over-year rate of 3% as of June, the Fed "still has more work to do," he said. "If inflation lingers above-target, it gets tougher to wring it out."
The longer prices stay high, the more consumers and businesses will build these higher prices into their costs. That means that businesses will have to keep their selling prices for goods and services high to keep up with their higher expenses. Since consumers, too, will have built those higher prices into their budgets, demand won't come down, so the prices will stay high, he explained.
Unemployment will likely have to rise
One factor keeping prices high, especially in the services sector, is the job market. When the job market is tight, as it has been, that keeps wages (and thus businesses' overall costs) high, so they charge more for goods and services. The Fed has forecasted that the unemployment rate, which is at 3.6% as of the most recent figures, will likely have to go over 4%, in order for inflation to come down to the Fed's 2% target.
In addition to keeping wages high, the abundance of jobs is keeping inflation elevated through its impact on rent, Henderson said. "When people get new jobs, they may need new housing, whether that's moving into an apartment or trying to buy a home." The inventory of single-family housing remains low, as are the vacancy rates among multifamily housing, both of which are keeping rent up, he explained.
As of June, the year-over-year cost of shelter was up 7.8%. That's one of the factors keeping core inflation—which excludes food and energy—at 4.8% year-over-year.
Positive and negative impacts of higher rates
The higher Federal Funds rate is continued good news for savers, as banks consequently will be offering higher interest rates on short-term savings vehicles such as savings accounts and certificates of deposit (CDs). Yields on money market funds will also go up, after an already-good year of attracting investors.
At the same time, it's bad news for consumers and businesses that have debt, such as credit cards. Companies that are highly leveraged, such as commercial real estate firms, will likely feel the impact most, Henderson said.
Auto manufacturers also may have to lower the prices of new cars in order to keep up demand, as higher interest rates are making it more expensive for consumers to finance cars, he continued. That may also be the case with other big-ticket consumer goods, such as appliances.
"Most all industries are going to be impacted," he said.