Federal Reserve NewsFed Fights Inflation With Another Big Rate Increase

Consumer giants including Coca-Cola, PepsiCo and McDonald’s this week cited shoppers’ willingness to keep spending despite higher prices. All three, however, noted that they were unsure how much more consumers would be willing to take.

“We are watching closely for signs of changing consumer behavior as the year goes on and as the average cost of the consumer basket continues to go up,” James Quincey, Coca-Cola’s chief executive, said on a call with analysts this week.

Chipotle Mexican Grill said that it planned to increase its prices further next month, to offset higher dairy, tortilla, packaging and wage costs. “The low-income consumer definitely has pulled back their purchase frequency,” Brian Niccol, the restaurant chain’s chief executive, told analysts on a call when asked whether he saw signs of customers changing their habits in response to higher prices.

Big banks, including JPMorgan Chase and Wells Fargo, were preparing for an economic downturn by setting aside more money to cover potential loan losses. “We are in a bit of an uncertain world,” James Gorman, Morgan Stanley’s chief executive, said on a call. “I don’t think this is the time to be overly aggressive.”

Big, cash-rich technology companies were also hit by economic worries. Microsoft reported lower-than-expected earnings on Tuesday and its chief executive, Satya Nadella, said the company was “not immune” from what was happening in the economy.

Viewed in isolation, that might bolster the case for faster rate increases, which would tend to reduce demand for labor and thus restrain wages, decreasing the money people have to spend and thus lowering prices (in theory).

On the other hand, that spending isn’t keeping up with inflation, meaning that consumers are buying less even though it’s costing them more. Or they’re skimping on optional expenses, since their disposable income has been eaten up by hard-to-avoid purchases like gasoline.

For vacation destinations, for example, that’s bad news: People have spent a lot to get there, so they have less for a splurge on local businesses.

“People are still traveling here, but what people do while they’re here has definitely been impacted,” said Matt Raker, executive director of Mountain BizWorks, a nonprofit lender in Asheville, N.C. “So businesses are worried; if they raise their prices, people might say, ‘Well, I might not do the zip line or go to as many restaurants.’”

Even for people staying at home, some spending categories usually viewed as necessities are taking a hit, especially since wages haven’t kept up with inflation, either. Omair Sharif, founder of the investment research service Inflation Insights, noted that grocery spending sank 5.5 percent when adjusted for inflation from January to May.

“To me, that’s the most obvious place where you’ve seen people cut back,” Mr. Sharif said. “Making it to work is more important than the amount of food you’re purchasing at the grocery store.”

So from the Fed’s perspective, that may allow more modest rate increases to do the trick, given that consumers are already making sacrifices in response to higher prices. They’re also in an increasingly bad mood, with surveys of confidence in economic conditions declining steadily.

This week’s meeting, however, is operating on stale data. Personal consumption expenditures for June won’t come out until Friday. Forecasters expect spending by that metric to rise by 0.9 percent from the previous month, likely just enough to keep up with inflation.

Credit Cards

Credit card rates are closely linked to the Fed’s actions, so consumers with revolving debt can expect to see those rates rise, usually within one or two billing cycles. The average credit card rate was recently 17.25 percent, according to Bankrate.com, up from 16.34 percent in March, when the Fed began its series of rate increases.

“With the frequency of Federal Reserve rate hikes this year, it will be a drumbeat of higher rates for cardholders every couple of statement cycles,” said Greg McBride, the chief financial analyst at Bankrate.com.

Car Loans

Car loans are also expected to climb, but those increases continue to be overshadowed by the rising cost of buying a vehicle and the price you pay for filling it with gas. Car loans tend to track the five-year Treasury note, which is influenced by the Fed’s key rate — but that’s not the only factor that determines how much you’ll pay.

A borrower’s credit history, the type of vehicle, loan term and down payment are all baked into that rate calculation.

The average interest rate on new-car loans was 5 percent in the second quarter, according to Edmunds, up from 4.4 percent in the same period last year. Last month, the share of new-car buyers paying $1,000 or more per month on their loans reached a record of nearly 13 percent, Edmunds said.

Student Loans

Whether the rate increase will affect your student loan payments depends on the type of loan you have.

Current federal student loan borrowers — whose payments are on pause through August — aren’t affected because those loans carry a fixed rate set by the government.

But new batches of federal loans are priced each July, based on the 10-year Treasury bond auction in May. Rates on those loans have already jumped: Borrowers with federal undergraduate loans disbursed after July 1 (and before July 1, 2023) will pay 4.99 percent, up from 3.73 percent for loans disbursed the year-earlier period.

Private student loan borrowers should also expect to pay more: Both fixed and variable-rate loans are linked to benchmarks that track the federal funds rate. Those increases usually show up within a month.

Mortgages

Rates on 30-year fixed mortgages don’t move in tandem with the Fed’s benchmark rate, but instead track the yield on 10-year Treasury bonds, which are influenced by a variety of factors, including expectations around inflation, the Fed’s actions and how investors react to all of it.

Mortgage rates have jumped by more than two percentage points since the start of 2022, though they’re down from their highs, as fears of recession have led traders to temper their expectations for Fed rate increases in the future, despite stubbornly high inflation, pushing bond yields lower in recent weeks.

Rates on 30-year fixed rate mortgages averaged 5.54 percent as of July 21, according to Freddie Mac’s primary mortgage survey, down from 5.81 percent a month ago but up sharply from 2.78 percent a year ago.

Other home loans are more closely tethered to the Fed’s move. Home equity lines of credit and adjustable-rate mortgages — which each carry variable interest rates — generally rise within two billing cycles after a change in the Fed’s rates.

Savings Vehicles

Savers seeking a better return on their money will have an easier time — yields have been rising, though they’re still pretty meager.

An increase in the Fed’s key rate often means banks will pay more interest on their deposits, though it doesn’t always happen right away. They tend to raise their rates when they want to bring more money in — many banks already had plenty of deposits, but that may be changing at some institutions.

Rates on certificates of deposit, which tend to track similarly dated Treasury securities, have been ticking higher. The average one-year C.D. at online banks was 1.9 percent in June, up from 1.5 percent the month prior, according to DepositAccounts.com.

The average five-year C.D. was 2.9 percent in June, up from 2.5 percent in May.

Others have argued that the Fed should continue to be forceful. Lawrence H. Summers, the former Democratic Treasury secretary, argued during an interview on CNN this week that the Fed needed to take “strong action” to control inflation and that allowing inflation to gallop out of control would be the “bigger mistake” than causing a recession.

Onlookers could be excused for struggling to make sense of the debate. Fed officials themselves acknowledge that their tools are blunt, that they cannot fix broken supply chains and that it will be difficult to slow the economy enough without causing an economic downturn. So why is the Fed doing this?

America’s central bank has for decades been what Paul Volcker, its chair in the 1980s, called “the only game in town” when it comes to fighting inflation. While there are things that elected leaders can do to combat rising prices — raising taxes to curb consumption, spending more on education and infrastructure to improve productivity, helping flailing industries — those targeted policies tend to take time. The things that elected policymakers can do quickly generally help mainly around the edges.

But time is of the essence when it comes to controlling inflation. If price increases run fast for months or years on end, people begin to adjust their lives accordingly. Workers might ask for higher wages, pushing up labor costs and prompting businesses to charge more. Companies might begin to believe that consumers will accept price increases, making them less vigilant about avoiding them.

By making money more expensive to borrow, the Fed’s rate moves work relatively quickly to temper demand. As buying a house or a car or expanding a business becomes pricier, people pull back from doing those things. With fewer consumers and companies competing for the available supply of goods and services, price gains are able to moderate.

Unfortunately, that process could come at a hefty cost at a moment like this one. Bringing the economy into balance when supply is constrained — cars are hard to find because of semiconductor shortages, furniture is on back order, and jobs are more plentiful than laborers — could require a big decline in demand. Slowing the economy down that meaningfully could tip off a recession, leaving workers unemployed and families with lower incomes.

Economists at Goldman Sachs, for example, estimate that the probability of a recession over the next two years is 50 percent. Already, signs abound that the economy is slowing as the Fed begins to push rates higher, with overall growth data, housing market trackers and some metrics of consumer spending showing a pullback.

But central bankers believe that even if the risks are difficult to bear, they are necessary. A downturn that pushes unemployment higher would undoubtedly be painful, but inflation is also a major impediment for many families today. Getting it under control is critical to putting the economy back on a sustainable path, officials argue.

“It is essential that we bring inflation down if we are to have a sustained period of strong labor market conditions that benefit all,” Jerome H. Powell, the Fed chair, said at his news conference last month.