Fed Funds Rate: Mixed Central Bank Messaging

Mixed Messaging from the Fed Chair

Where is the Fed Funds Rate going? “These rate hikes have been large and they have come quickly, and it’s likely that their full effect has not been felt by the economy. So there’s probably some additional significant tightening in the pipeline… As the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases while we assess how are our accumulative policy adjustments are affecting the economy and inflation.” – Fed Chair, Jerome Powell

“We do see there are two-sided risks: There would be the risk of doing too much – imposing more of a downturn on the economy than was necessary, but the risk of doing too little and leaving the economy with this entrenched inflation – it only raises the costs of dealing with it later to the extent that people start to see it as part of their economic lives on a sustained basis. I don’t think that’s happened yet, but when that starts to happen, it just gets that much harder and the pain will be that much greater… Restoring price stability is just something we have got to do. There isn’t an option to fail.” – Fed Chair, Jerome Powell

Powell’s Outlook

Over the past few press conferences, Powell was clear about telegraphing what lay ahead at coming gatherings, though this time around, things were less specific.

Where is the Fed Funds Rate headed?

“While another unusually large increase could be appropriate at our next meeting, that is a decision that will depend on the data we get between now and then,” Powell said last Wednesday. “It’s time to just go to a meeting-by-meeting basis and to not provide the kind of clear guidance that we had provided.” That could make things more opaque going into the second half of 2022, though it’s not as extreme as the ECB, which last week scrapped forward guidance “of any kind.”

In June 2022, the Federal Reserve expected to lift rates to a target range of 3.25-3.5 percent by the end of this year. To do so, officials would have to raise rates by another amount larger than 25 basis points at one of its three remaining gatherings this year.

Taken together, 3.25 percentage points of tightening would be the most in a single year since the 1980s, making 2022 could be the most hawkish year for the Fed on record. Additionally, the Fed is also well underway with shrinking its massive portfolio of assets that ballooned to nearly $9 trillion.

The decision to move rates depends largely on what happens with inflation. Even with the highest price pressures in 40 years, consumers have been willing and ready to spend. Consumers were sitting on about $2.1 trillion of cash, largely a result of stimulus money, as of May 2022. Consumer staples have felt the hardest hit from inflationary pressures and so many Americans have been forced to deal with those price increases directly.

A worsening job market, however, puts robust consumption in jeopardy. Economists surveyed project employers will add roughly 193,000 new positions each month over the next year, which is a sharp slowdown from the past year’s 545,000 average monthly pace.

Current Fed Funds Rate – Midpoint

The Fed’s benchmark federal funds rate is now in a target range of 2.25 to 3.5 percent.

Once rates rise higher than that point — 2.5 to 2.75 percent — the Fed will be officially taking from the U.S. economy, rather than adding to it.

Powell in a post-meeting press conference acknowledged the economy had softened, including the labor market.

“The committee is strongly committed to returning inflation to its 2 percent objective,” officials said in their post-meeting statement. “Recent indicators of spending and production have softened. Nonetheless, job gains have been robust in recent months, and the unemployment rate has remained low.”

Fed Funds Rate Hikes and What it Impacts

Mortgages and Refinancing Activity: The 10-year Treasury yield, which is the main benchmark for the 30-year fixed-rate mortgage, fell to 2.81 percent on July 25. This is down 0.68 percentage points from its June 14 high of 3.49 percent, as investors brace for a strong likelihood of an economic slowdown or recession at worst.

Year-to-date however, the overall trend is up. Mortgage rates have surged in 2022, climbing to 5.76 percent in the week that ended on July 20 from 3.04 percent a year ago.

Homeowners who’ve already locked in a fixed-rate mortgage will feel no impact from the Fed’s moves. Potential homebuyers, however, are likely facing elevated rates, on a year-over-year basis. Patience may be required for the rest of this year as homebuyers shop around.

If inflation keeps inching higher, the 10-year Treasury yield could rise further, as investors sell inflation-prone investments for larger returns. But news of an economic slowdown, slumping GDP, and rising unemployment numbers could lead to lower long-term yields, especially if the Fed indicates that it’s likely to slow the pace of rate hikes at its three remaining meetings in 2022.

Remember that price and yield moves inversely. Price action is largely determined by demand – buying and selling of securities.

Higher rates are already starting to cool parts of the housing market. Refinance activity has fallen by 80 percent in the first three months of 2022.

Borrowers: You want to refinance variable-rate debts into fixed loans and shrink any high-interest debt. If you have credit card debt, utilize a balance transfer card that could help shave down interest payments, depending on your balance and the cost of the upfront transfer fee.

The burden of credit card debt is clear. The average credit card rate was 16.2 percent a year ago, when the Fed’s benchmark interest rate was still at near-zero percent. That has so far soared 1.09 percentage points to 17.3 percent at the end of July 2022.

Cash Savings: Savings accounts in July 2021 were offering an average yield of 0.51 percent, ranging from as high as 0.55 percent and as low as 0.40 percent. Today, however, many banks are paying an average rate of 1.42 percent. The highest-yielding savings account in the nation is offering a 2.02 percent APY. Taking advantage of online banking, which is able to offer more competitive rates than depository institutions.

With rates likely still on the rise, it is likely too early to lock in your money with a CD, particularly if the maturity is longer than one year. Liquidity is also important, especially if the money you’re holding is being used as an emergency fund.

Investors: I continue to see 2022 as a long-term buying opportunity, but acknowledge this will be a bumpy ride. The S&P 500 is down more than 17 percent year-to-date, while bitcoin is down more than 50 percent, as the Fed takes liquidity and easy money away from the marketplace.