- Higher-than-expected inflation in August means the Fed is likely to support another huge rate hike next week.
- Rate increases have already made mortgages, car loans and credit cards much more expensive for Americans.
- Markets are now expecting larger increases in 2023, which will have households bracing for more economic pain.
Since the beginning of 2022, it has become much more expensive to get a mortgage, carry credit card debt, or take out a loan of any kind.
The new data suggests the surge has only just begun, and could add even more pain in the form of job cuts and minor raises.
The Fed’s fight against inflation hit a fork in the road when the Consumer Price Index was updated on Tuesday. If inflation had cooled more than expected in August, the central bank could have eased interest rate increases and the economy could have avoided a growth slump.
That didn’t happen. Inflation slowed, but just barely. The yoy rate decreased to 8.3% from 8.5%, but prices rose 0.1% through August alone, accelerating after being flat the previous month. Fed officials have made it clear that they will only back down on their rate hikes once they see “convincing evidence“That inflation is slowing. The August report doesn’t come close to that description.
“There is no chance now” that the Fed will slow down and raise rates by just half a percentage point, said Ian Shepherdson, chief economist at Pantheon Macroeconomics. Markets, economists and analysts see another increase of 0.75 points, the third in a row, as almost certain.
Interest rates serve as the Fed’s best tool for slowing the rate of price growth. Higher borrowing costs tend to slow economic growth as Americans rein in spending and businesses delay expansion plans. Demand falls, supply catches up, and the pressures driving prices up ease.
Higher rates also put more pressure on the labor market. Companies tend to slow their hiring plans and give smaller raises when loans are more expensive. The decline in demand can even lead to significantly lower revenues and cause companies to cut jobs altogether.
Tuesday’s inflation figure didn’t just change the estimate for the Fed’s September meeting. Economists now brace for a much more aggressive rate hike cycle through the rest of the year, complete with bigger hikes and few signs of slowing.
For the average American, that will mean expensive loans, smaller raises and a higher risk of job loss.
The Fed’s rate hike plans have become much more aggressive
In just one week, the bets on how the Fed will raise rates have gotten much higher. Traders are now expecting a considerably more aggressive upside cycle through the end of 2022.
Market positioning last week signaled a 76% chance of a 0.5 point rise, according to data from CME Group. A slim majority now sees officials raising rates by another 0.75 point in November to a range of 3.75% to 4%.
Market bets indicate that the Fed will not stop there. CME data pegs the odds of a half-point rise in December at 40%. A week ago, options positioning signaled a 75% chance that rates would only go up a quarter point at that meeting.
In short, investors are now bracing for two more 0.75 point gains and a 0.5 point gain to close out the year. That will leave rates a half percentage point higher at the end of 2022 than expected just a week ago. After weeks of aggressive language from Fed officials and a disappointing inflation report, it appears the market is finally coming to terms with the central bank’s “go big or go home” outlook.
“The Fed has made it clear it won’t take any chances, even if that raises the risk of over-tightening,” said Pantheon’s Shepherdson.
That tightening is already having an effect on Americans’ finances. Mortgage rates rose last week to the highest level since 2008, further eroding housing affordability in the already tense housing market. credit card rates have moved sharply higher until 2022 and increased interest payments for those with large debts. And since it typically takes about a year for rate hikes to be fully felt throughout the economy, those tightening effects are only going to get more intense.
Fed officials have also made it clear that they want to avoid the bigger risks that monetary tightening brings. Powell warned in August that cooling off inflation with big rate hikes “bring some pain“to households and businesses in the form of a less advantageous labor market and more expensive loans. That discomfort will probably be worth it in the long run, he added.
“These are the unfortunate costs of reducing inflation, but failing to restore price stability would mean much greater pain,” Powell added.