The Fed issued its 10th consecutive rate hike since March 2022, pushing the federal funds rate to a target range between 5% and 5.25%, the highest level since 2007. Clearly, while inflation is improving, the Fed’s job is not to expired.
“The rate increase is a signal that the fight against inflation is far from over, despite signs that things are moving in the right direction,” said Bruce McClary, senior vice president of communications at the National Corporation for Credit Counseling. “It’s been over a decade since we’ve seen rates this high.”
With inflation slowing and jobless claims still below historical averages, some experts expected the Fed to hold off on raising interest rates this month. However, with another bank failure in the news – the recent collapse of the First Republic – and inflation falling short of the 2% target, the Fed’s decision to gradually raise interest rates is not surprising.
“My colleagues and I understand the hardships caused by high inflation, and we remain strongly committed to bringing inflation down to our 2% target,” Fed Chairman Jerome Powell said at the FOMC meeting’s press conference.
Since early 2022, the Federal Reserve has been working to cool price hikes and tame runaway inflation. From groceries to gas, the cost of daily necessities has skyrocketed. In response, the Federal Reserve aggressively raised interest rates in an effort to bring prices down. As the Fed raises interest rates, the cost of borrowing for loans, credit cards, and mortgages has also increased, making financing less expensive. However, it also increased interest rates on savings, certificates of deposit, and money market accounts.
Although this rate increase will make borrowing more expensive, the most important takeaway from the Fed’s May meeting is the Fed’s signal that future increases will be held back, said Tom Graff, head of investments at Facet.
Here’s what you need to know about inflation, what’s next for the economy and how to protect your money.
What is going on with inflation?
Inflation is now at 5% year over year, according to the Bureau of Labor Statistics. That’s a stark difference from last year, when inflation reached record highs in June with an annual increase of 9.1%. From February to March, most categories saw a decrease in the total cost, with some exceptions such as housing and food away from home. But even though inflation has slowed, prices are still high across the board, making it difficult for your dollar to stretch any further.
During periods of high inflation, your dollar has less purchasing power, so whatever you buy is more expensive, even though you may not get more money back. Despite signs that inflation is declining, many Americans still live from paychecks to paychecks, and wages are not keeping up with inflation rates.
One of the Fed’s responsibilities is to keep the inflation rate low, ideally around 2%. Previous Fed rate increases appear to have helped reduce inflation, but rates remain elevated, suggesting that there is still some work to be done.
What does a higher interest rate mean for the economy?
Prices will not fall overnight. Experts expect 2023 to be another challenging year as the cost of living remains high and interest rates drive up the cost of borrowing.
Many experts predict that the Fed’s rate hike will send us into a recession: a contraction, not a growing economy. The Federal Reserve acknowledges the negative effects and potential risks of this restrictive monetary policy. And at this point, a recession seems inevitable.
“I see a 70% chance of a recession right now,” Derek Delaney, a certified financial planner and founder of Farmed Financial Planning, said in March. If unemployment rises, a recession could come sooner – but what happens next with inflation will play a major role in the likelihood and size of a recession.
“Inflation will not return to normal without some economic slowdown,” Graf said in a message Powell made clear months ago. “There is still a risk of some pain from this slowdown.”
What does this mean for your money
The recent Federal Reserve rate hike means that borrowers will continue to see higher interest rates on mortgages, credit cards, and personal loans. On the flip side, as interest rates continue to rise, you can benefit from increased earnings on your savings.
“Raising the Fed rate can lead to higher returns on savings accounts,” McClary said. “That’s the positive side of the equation.” “The bad news is related to the impact on the cost of borrowing. If you’re in debt, you’ll pay more.”
If you have debt or are concerned about future economic instability, here are some steps you can take now to prepare.
Dealing with outstanding debts
Raising interest rates for the tenth time, even just a little bit, means banks will follow suit, making it more expensive to finance a car or buy a home. Higher rates also make it more expensive to refinance your mortgage or student loans. Furthermore, raising the Fed indirectly raises interest rates on credit cards, so if you carry a balance from month to month, it becomes more expensive to pay off your debt.
Before getting a new loan or mortgage, understand exactly what you’ll owe: repayment schedule, potential fees, and interest rate. Create a debt repayment plan to reduce balances as quickly as possible on any outstanding debt.
“Look at the numbers and make informed decisions,” said Bobbi Rebell, certified financial planner and author of Launching Financial Grownups. “And also to communicate with your family because very few of us work in the same economy.” She said converting high-interest debt into a lower or fixed-rate option should be considered, if possible. You could also consider a balance transfer card — as long as you plan to pay the balance off before interest is due — or a debt consolidation loan.
Check if your debt carries a fixed or variable interest rate. Many personal loans and mortgage loans have fixed interest rates, so if you borrowed recently, you may have a high interest rate that will last for the life of the loan. On the other hand, most credit cards have a variable interest rate – which means that the already high APR (averaging over 20% at the moment) on any balances will only grow as rates go up.
And even if we see the last rate hike by the Fed for some time, remember that the cost of borrowing will not come down overnight. “If the Fed slows or stops raising interest rates, it doesn’t necessarily mean your rate will go down. It might just mean it won’t go up,” Rippel said. Don’t wait to take action. If you need to move debt into a fixed rate loan, you better move now in case rates increase further in the coming months.
Build an emergency savings fund
“If you have extra money in your bank account, you should definitely check the interest rate,” Graf said. Some traditional savings accounts have not kept up with inflation, and may lose interest.
APRs for savings accounts have increased significantly this year, topping out at 5% APY. But the savings and CD rates will soon plateau. While some banks may raise interest rates slightly in the coming days, experts don’t expect rates to rise much more. So if you’ve been waiting for a long-term CD lock, now is the time to act.
“The interest rates on (some) certificates of deposit, for example, are the highest in more than 15 years,” Wu said.
However, this does not mean that you should transfer all of your money out of a savings account.
Even if prices start to drop, building your emergency fund is crucial. In the meantime, you can earn a nice return on your money, but even after the rates drop, we recommend keeping emergency savings somewhere, such as a high-yield savings account. Over time, you may not earn the best rate if banks don’t raise APY as aggressively as last year. You will have access to funds when needed, and can continue to make regular contributions.
The most important tip is to shop around and compare rates before opening a new bank account. “Prices on CDs, in particular, can vary widely,” Wu said.
The amount you need in your emergency fund is unique to your situation, though many experts recommend between three and 12 months of expenses. Start saving what you can now – money can come in handy if you’re struggling with a job loss or unexpected costs as the economic downturn continues.