What to Know as the Fed Approaches the End of the Current Rate Hike Cycle

For the past 15 months, consumers and businesses have had to adjust to ever increasing interest rates thanks to 11 consecutive rate hikes enacted since March 2022 by the Federal Reserve Board. With the latest decision by the Federal Reserve Open Markets Committee (FOMC) to hold rates steady, it appears the historic cycle of rising rates may be drawing to a close. If so, the end of rising rates will offer a mix of good and bad for consumers. To get a clearer picture of what it may mean going forward, it’s important to understand how we got to where we are now.  

Fanning the flame of inflation 

When COVID arrived in the U.S. and state and local officials shut down large portions of the country, the federal government quickly acted to prevent a serious health crisis from devastating the economy. Through both fiscal (direct spending and stimulus checks) and monetary (rate cuts and injecting liquidity into the banking system through the purchase of U.S. Treasurys) policy, officials were able to soften the economic blow from the pandemic.  

Unfortunately, the significant infusion of liquidity (money) resulted in too many dollars chasing too few goods as factories struggled to keep up with demand due to bottlenecks in the supply chain and workers sheltering at home. Then Russia’s invasion of Ukraine sent commodity prices soaring, which raised the cost of producing goods. The result was inflation climbing to levels not seen in 40 years.

To rein in inflation, the Fed began raising interest rates to cool off demand. To date, the Fed has raised rates a total of 500 basis points (5 percent) to a range of 5 to 5.25 percent. The effort has been largely successful, with the Consumer Price Index declining from a peak of 9.1 percent year over year in June 2022 to 4.9 percent as of April of this year. Because rate hikes take some time to fully affect the economy, it is widely believed that inflation will continue to ease in the coming months. 

With price pressures retreating, Fed Chair Jerome Powell has said that the FOMC needs to consider whether continuing to raise rates may result in a recession. As such, many believe the Fed will hold rates steady at current levels and may begin to ease them later this year if a recession emerges.  

What a pause means for the rates you pay on debt

A pause in rate hikes should be welcome news for consumers who have variable rate mortgage loans and those who have watched the interest rate on their credit cards steadily climb over the past year. Because the interest rate set by the Federal Reserve (known as the Fed Funds Target Rate) is used as a basis for most variable interest debt in the U.S., a pause in rate hikes should translate into some stabilization of the amount charged by banks and credit card companies to consumers. 

Unfortunately, a Fed pause is unlikely to lead to lower rates for consumers in the near term. As such, mortgage rates aren’t expected to retreat meaningfully from their current levels once the Fed stops acting. 

Potential good news for bond holders 

The rise in rates over the past 15 months has been hard on consumers who hold bonds in their investment portfolios. Because bond prices move in the opposite direction of yields, higher rates have meant that many bonds have decreased in value. While high-quality bonds or Treasurys that are held until maturity typically recoup losses in value as they approach their redemption date, the rise in rates over the past year has hurt people who were forced to sell bonds before their value returned to par (face value). 

Interest rates on savings  

While a pause or end to rate hikes should be good news for borrowers, the move may not be as welcome for savers. Since the beginning of the current rate hike cycle, the national average yield on Treasury money market savings accounts, according to data form the Federal Deposit Insurance Corp., has risen from a paltry 0.08 percent in March 2022 to 4.83 percent as of May 15. With the Fed expected to wind down its rate hiking efforts, consumers should expect interest yields on their savings to stop climbing.  

If rates do stabilize, it could be a good time to consider certificates of deposit (CDs) for income-sensitive savers. Because CDs generally prohibit depositors from withdrawing their savings for a set period of time or face significant penalties, some savers have been hesitant to use these types of accounts for fear that rates will continue to climb after they’ve agreed to lock in a lower rate. More stability on the interest-rate front could alleviate some concerns that future deposit rates will rise dramatically in the near term. 

What does a pause mean for the economy?  

The immediate impact of a pause in rates will vary for consumers depending on their individual situations. However, an end—or at least a temporary pause—to rate hikes could mark an approaching tipping point for the economy. That’s because it can take months or even years for the full effect of a series of rate hikes to fully work through the economy.  

Given that the Fed raises rates to cool down an overheated economy, it makes sense to wonder: If the Fed thinks it has raised rates enough, does that mean we are headed for a recession? The answer is “it depends.” Every recession is different, with varying causes, duration and severity. During the past year, the economy has shown signs of cooling, and areas of it—such as manufacturing—appear to be at or in recessionary levels. During the past 30-plus years there have been five separate Fed tightening cycles, with four of them featuring multiple rate hikes over the course of one to three years (the 1997 “cycle” was limited to a single increase). The span between the initial hike and the start of a recession was about four years. 

While we believe that we are headed toward a recession potentially in the second half of this year, we expect it will be mild, and importantly, the Fed will have the ability to cut rates if needed to prevent a potential recession from becoming severe. A look back at history shows that the Fed has historically been nimble when it comes to changing direction on rates, with the first rate cut happening just 5.5 months after the last hike. If an economic contraction creates a significant jump in unemployment, we believe the progress already made on alleviating inflation will allow the Fed to act quickly to spur the economy.

Regardless of whether you’re a saver or have some debts to repay, a pause in rate hikes offers a great opportunity to revisit your financial plan to make sure you’re still on track and that no adjustments are necessary. If you are unsure of the best course of action for you, working with a financial advisor can be a great first step. 

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