Interest Rates: Fed Sticks With Three-Quarter Point Increase

Kiplinger’s latest forecast on interest rates

Illustration of interest rates
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As expected, the Federal Reserve raised its short-term interest rate by three-quarters of a percentage point, a large hike, but less than the full-point raise some expected. Chair Jerome Powell continued to emphasize the Fed’s commitment to raising interest rates to slow the economy in order to fight inflation. In May, Powell thought only half-point rate hikes would be needed, but given strong inflation momentum, since June the Fed has done three-quarter point rate increases. Either three-quarter or half-point hikes are likely at the November and December meetings, taking the fed funds rate to 4.0% or 4.5%. After this, the Fed is likely to slow its pace significantly as inflation pressures ease.

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Powell emphasized that his views haven’t changed since he highlighted the Fed’s shift to a more aggressive stance in his Jackson Hole conference speech on Aug. 26. There, he warned against easing restrictive monetary policy too early. In his view, there is a real danger that a period of prolonged inflation could induce businesses and workers to automatically add a certain inflation rate into their wage and price calculations. That mentality would cause high inflation to become a self-perpetuating cycle, which would lengthen the time needed for higher interest rates to bring down inflation. Better to slow the economy enough to bring down inflation right away before this can happen. Interest rate hikes are needed because the economy’s underlying momentum is still strong, as evidenced by continuing labor shortages.

Powell did say that the Fed would ease its rate hikes at some point in the future, but that the public should not expect one or two months of lower gasoline prices to get the Fed to change its course. What this likely means is that the Fed will want to see smaller price increases for consumer goods and services, beyond the notoriously volatile categories of food and energy, before it will change course. That broader slowing of price rises would indicate that underlying inflation momentum is easing. Powell noted two good signs in the easing of supply chain disruptions and declining commodity prices. Although Powell didn’t mention this, one of the main components of consumer services prices is rent, which has been rising strongly because of the housing shortage. Home prices have likely peaked already, given the slowing of the housing market because of higher mortgage rates, but rent increases tend to lag behind home prices, so their momentum could continue for a few months.

Short-term interest rates will rise along with the federal funds rate. Rates on home equity lines of credit are typically connected to the federal funds rate, and move in lock-step. Rates on short-term consumer loans such as auto loans will also be affected.

Expect the 10-year Treasury yield to stay around 3.5% until evidence of slowing inflation occurs. Eventually, rates should fall as indications of the economy’s slowing growth become evident.

Mortgage rates are rising again, but should be close to a peak. 30-year fixed-rate loans are at 6.0%, and around 5.3% for 15-year fixed loans. When inflation is high, mortgage rates tend to stay higher longer, while Treasury rates tend to be more sensitive to signs of economic slowing. It is possible that mortgage rates could ease a bit later this year if the bond market thinks that progress is being made against inflation, or if the economy slows more than anticipated.

Corporate high-yield bond rates are rising again because of the Fed’s rate hikes and because the threat of economic slowdown tends to weaken prospects for debt-laden companies. CCC-rated bond yields are at 15.6%. AAA bonds are yielding 4.4% and BBB bonds, 5.6%.

Source: Federal Reserve Open Market Committee (opens in new tab)

David Payne
Staff Economist, The Kiplinger Letter
David is both staff economist and reporter for The Kiplinger Letter, overseeing Kiplinger forecasts for the U.S. and world economies. Previously, he was senior principal economist in the Center for Forecasting and Modeling at IHS/GlobalInsight, and an economist in the Chief Economist's Office of the U.S. Department of Commerce. David has co-written weekly reports on economic conditions since 1992, and has forecasted GDP and its components since 1995, beating the Blue Chip Indicators forecasts two-thirds of the time. David is a Certified Business Economist as recognized by the National Association for Business Economics. He has two master's degrees and is ABD in economics from the University of North Carolina at Chapel Hill.