US interest rates may need to stay high for longer to beat inflation, Fed says

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The hefty interest rate hikes of the past two years are expected to take longer than previously thought to tame inflation, with several Federal Reserve officials hinting that there may be minimal, if any, rate cuts this year.

Both Fed policymakers and some economists are voicing concerns that the increased borrowing costs aren’t having the anticipated impact. Despite the Fed’s aggressive rate hikes, Americans aren’t spending significantly more of their incomes on interest payments than they did a few years ago. This suggests that the higher rates might not be effectively curbing spending or cooling inflation.

Joseph Lupton, a global economist at J. P. Morgan, observed, “What you have right now is a situation where these high rates aren’t generating more braking power on the economy. That would suggest that they either need to stay high for longer or maybe even higher for longer, meaning rate hikes might come into the conversation.”

Fed Chair Jerome Powell, said that an interest rate increase was “unlikely,” but he didn’t completely dismiss the possibility. Mr Powell stressed that the Fed needs more time to ensure with “greater confidence” that inflation is moving back towards the Fed’s 2% goal. “I think the Fed’s telling you hikes are not quite as on the table as the market was expecting,” said Gennadiy Goldberg, an economist at TD Securities.

On Friday, Dallas Federal Reserve President Lorie Logan stated that it is “just too early to think” about cutting rates, according to news reports. She also mentioned that it is uncertain whether the Fed’s rate is high enough to tackle inflation. Although Logan is one of the 19 officials on the Fed’s interest-rate setting committee, she does not have a vote on rates this year.

Many will likely be disheartened by the prospect of sustained higher borrowing costs, from Americans waiting for mortgage rates to drop before purchasing homes, to Wall Street traders anticipating a rate cut, and even President Joe Biden, who could see his reelection campaign boosted by lower rates.

The government is set to release April’s inflation report on Wednesday, with economists predicting a slight decrease in inflation to 3.4%, down from March’s 3.5%. However, since January, when it was at 3.1%, inflation has been on the rise after a significant drop last year, sparking worries that the progress in curbing inflation may have hit a snag.

In its fight against soaring inflation, which reached a peak of 9.1% in June 2022, the Fed has elevated its key rate to a 23-year high of 5.3%. Despite the significant increases, Americans spent just 9.8% of their after-tax income on interest and principal payments on their debts in the fourth quarter of last year.

This is only slightly higher than the 9.5% they spent two years earlier – before the Fed increased rates – a historically low percentage. So why hasn’t this figure increased more? The answer lies in the millions of American homeowners who refinanced their mortgages at extremely low rates over the past decade and a half when the Fed kept its key rate almost at zero to support the economy.

As a result, their mortgage payments remain low, leaving their finances largely unaffected by the Fed’s policies. Consumers who have paid off their cars or took out low-rate five-year car loans before rates increased have also felt minimal impact.

According to mortgage giant Freddie Mac, the average rate for a new 30-year mortgage is nearly 7.1%. However, Goldberg estimates that the average rate on all outstanding mortgages is just 3.8%, not much higher than the 3.3% when the Fed started to increase rates.

The difference between new rates and the average outstanding is the highest it’s been since the 1980s. “One of the things we hear is that maybe because so many Americans refinanced their mortgages when mortgage rates dropped during the pandemic … people are not feeling the bite of higher mortgage rates yet,” Neel Kashkari, president of the Federal Reserve’s Minneapolis branch, said last week. “If that’s true, and I think there’s some truth to that, then it may take longer” for the Fed’s rate hikes “to be fully felt by the housing market and by the economy more broadly.”

Many large corporations also locked in low rates before the Fed began hiking, further limiting the impact of higher borrowing costs. “I think the most likely scenario is where we are right now, which is just we stay put for an extended period of time,” Kashkari said, referring to the Fed’s key rate.

There are signs that higher rates are causing more financial struggles for many Americans, as delinquencies on credit cards and auto loans rise. And many younger Americans are becoming increasingly concerned that, with mortgage costs so high, they will not be able to afford a home.

And Americans, in total, are carrying much less debt as a percentage of their incomes than they did during the housing bubble 15 years ago, Lupton notes. Tom Barkin, president of the Richmond Federal Reserve, recently stated, “With consumers and businesses alike sheltered from higher interest rates thanks to pandemic-era debt paydowns and refinancing, their aggregate interest burden is not yet historically elevated,” adding, “To me, that suggests the full impact of higher rates is yet to come.”

Goldberg noted that as more Americans decide to buy homes regardless of raised mortgage rates – either due to job relocation or familial transformations – the increased borrowing costs will begin to make an impact. He also pointed out that over time, more firms will find themselves borrowing at these inflated rates as their low-interest loans mature.

“The longer we stay here, the more people can’t wait,” Goldberg explained. “If the Fed can wait out consumers, that would be one way that higher for longer actually translates to Main Street.”