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June Fed meeting preview: Brace for fastest rate hike since 1994 to battle too-high inflation

Federal Reserve Chairman Jerome Powell speaks at press conference illustration
Image by Getty Images; Illustration by Bankrate
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Economists like to say interest rates take the elevator down and the staircase back up. The metaphor highlights just how swiftly the Federal Reserve slashes borrowing costs during economic crises — and how gradually the Fed lifts rates when the economy is healing.

This time, however, interest rates might be taking an escalator ride toward the top.

Will the Fed hike rates by three quarters of a percentage point in June?

The Federal Open Market Committee (FOMC) looks poised to fast-track the tightening cycle when it wraps up its June 14-15 rate-setting meeting. How big of an adjustment is the ultimate question. After a red-hot May inflation report, officials are going to consider raising interest rates by three quarters of a percentage point — or 75 basis points — for the first time since 1994, according to The Wall Street Journal. That’s after Fed Chair Jerome Powell previously told consumers and investors the Fed was likely to raise rates by another half point at the June gathering.

The Fed is also set to update its Summary of Economic Projections, which will show where policymakers see inflation, unemployment, growth and borrowing costs heading over the next two years. Baked into those insights will be what Powell and Co. have already foreshadowed: Officials expect another big rate hike in July to lower inflation.

If all goes as expected, the Fed’s key interest rate benchmark will have risen 1.5 percentage points in just a three-month span. Your wallet is definitely feeling it, whether it’s noticeable in skyrocketing mortgage rates or volatile stock prices. But even then, the Fed’s benchmark is just barely going to be back at 2019 levels, and the path forward isn’t clear.

“It’s easy to talk tough when interest rates are low, unemployment is low and inflation is high,” says Greg McBride, CFA, Bankrate chief financial analyst. “But that job is going to get tougher the more they push up rates, especially if inflation remains stubbornly high and we see a noticeable slowdown in the economy and job market.”

Here are the four biggest questions surrounding the Fed’s June meeting — and how it could impact your wallet.

1. How much is the Fed going to hike interest rates in 2022?

For consumers, the Fed’s June meeting will be an especially important one: The updated economic projections along with the rate decision will be the first codified look at officials’ game plan for the rest of the year.

The last iteration put the federal funds rate in a target range of 1.75-2 percent by the end of 2022, according to its so-called “dot plot” chart, a threshold policymakers could be just 25 basis points away from if they approve a three-quarter-point hike.

After that, the Fed looks like it has four possible policy paths: It can either keep raising rates by half a percentage point, shift up to 75-basis-point increases, slow down to hiking rates in more traditional quarter-point increments — or opt for a pause in the tightening cycle altogether.

The latter two are looking especially unlikely after consumer prices reaccelerated in May at the fastest pace since December 1981, rising 8.6 percent from a year ago after cooling slightly to 8.3 percent in April. That leap was driven by big increases in gas prices, which hit new record highs throughout May and into June, soaring to a record $5.02 a gallon on June 14, according to AAA.

“Any hopes that the Fed can ease up on the pace of rate hikes after the June and July meetings now seems to be a longshot,” McBride says. “Inflation continues to rear its ugly head, and hopes for improvement have been dashed again.”

But as always, there’s a high degree of economic uncertainty, especially when it comes to inflation. Officials don’t have a crystal ball, and policymakers have clear blind spots. That makes penciling in the path forward especially difficult right now.

Between now and September, there are three more consumer price index (CPI) reports and three more readings of another key inflation gauge the Fed officially targets: the personal consumption expenditures (PCE) index set to be released.

“Right now, it’s very hard to see the case for a pause. We’ve still got a lot of work to do to get inflation down to our 2 percent target,” said Fed Vice Chair Lael Brainard in a June 2 interview on CNBC. “If we don’t see the kind of deceleration in monthly inflation prints, if we don’t see some of that really hot demand starting to cool a little bit, then it might well be appropriate to have another meeting where we proceed at the same pace.”

So far, just one Fed official has hinted about a possible interest in pausing — Atlanta Fed President Raphael Bostic — though he’s also stressed that the path he supports depends on the data.

“I do want to make it clear that nothing is off the table,” Bostic said in a May 23 public appearance.

At the heart of that debate is the ultimate question: How high do interest rates have to be to cool inflation without unnecessarily slowing the economy?

Knowing that point requires estimating the threshold at which rates are no longer stimulating economic growth — the so-called “neutral rate of interest.” Even in traditional times, policymakers don’t agree on where it is. The median estimate puts it at 2.5 percent, though forecasts are as low as 2 percent and as high as 3 percent. Some officials may want to go even higher than neutral, while others might not feel comfortable going much past it. The higher rates climb, the more difficult the rate debate becomes.

“They could have a whole lot harder time coming to agreement later this year,” says Vincent Reinhart, chief economist at Dreyfus and Mellon and a former Fed official. “But for now, they can agree, and they agree because no matter what you think the neutral rate is, you do agree it’s below the neutral rate now.”

2. How much will a lesser-known tool push up borrowing costs?

Rate hikes aren’t the only way officials are removing stimulus from the economy. The Fed is also shrinking its balance sheet — a process that officially kicked off on June 1, though the first batch of securities won’t mature until June 15.

Officials already agreed on that pace at the May meeting: From June through August, they’ll let $47.5 billion worth of assets roll off their books at maturity. Then, that number will increase to $95 billion by September. About two-thirds of those assets will be Treasurys; roughly one-third will be mortgage-backed securities.

The Fed doesn’t have plans to outright sell any of those assets — but experts aren’t convinced it won’t eventually come into play, especially for mortgage-backed securities. That’s because 97 percent of the $2.7 trillion stockpile that the Fed has amassed will mature more than 10 years from now. The impact of such a move on consumers is far from certain.

“If inflation is still really high and the economy is overheating, then mortgage rates would go up further if the Fed were selling bonds,” McBride says. “But mortgage rates would probably go up anyway if they weren’t selling bonds with that backdrop. And if inflation has peaked and the economy is slowing and the Fed starts selling bonds, the impact and magnitude is much less certain.”

3. From volatile markets to now recession fears, did the Fed move too late?

The Fed’s balance sheet and rate hike plans are going to be crucial because the continued expansion of the world’s largest economy is at stake.

Fed officials hope they can softly land the economy on the runway. Thanks to strong consumption, a near record number of job openings and continued job creation, policymakers hope the economy has enough buoyancy left to let some air out of the balloon.

But higher rates disincentivize businesses to make investments. Some could even start to cut projects or staff. Companies from Netflix and Robinhood to Peloton and Carvana have already notably cut staff in 2022.

“The Fed raising rates and tightening conditions makes investments a much more difficult decision,” says Eric Merlis, managing director of global markets at Citizens Bank. “When money is free, you can make some bad decisions, but when your mistakes start costing you, you tend not to make as many decisions. The lack of investment leads to lack of employment.”

Even absent of joblessness, slower demand and subdued consumption could weigh on job openings, zapping away what’s given jobseekers an incredible amount of bargaining power at a time when the pool of available workers outnumbers the amount of job openings by almost two to one.

All of that shows that the escalator ride to the top is already proving to be difficult as pessimism about the U.S. economy builds. J.P. Morgan Chase CEO Jamie Dimon on June 1 warned that an economic “hurricane” is coming, and no one knows if it will be “a minor one or Superstorm Sandy,” he said. The S&P 500 officially entered a bear market in Tuesday trading and is down nearly 22 percent so far this year.

That’s not to say higher interest rates aren’t necessary at a time when inflation is at a 40-year high — but whether the Fed should’ve started walking stimulus back even earlier, when it had momentum on its side. In 2021, for instance, massive amounts of fiscal stimulus sent the economy into a sugar high.

“They have waded into the pool when they should’ve done a cannonball into the deep end,” McBride says. “There are several possible outcomes, and only really one of them is good, and it’s arguably the least likely outcome — that would be the soft landing.”

Cooling inflation is even harder when supply chain bottlenecks, COVID-19 lockdowns abroad and the conflict in Russia are still major culprits. Yet, inflation is currently more than three times higher than the Fed’s objective.

“It’s not going to be easy,” Powell said at the Fed’s May news conference. “And it may well depend, of course, on events that are not under our control. But our job is to use our tools to try to achieve that outcome, and that’s what we’re going to do.”

4. What might the Fed do if unemployment starts to rise?

Cleveland Fed President Loretta Mester said Fed officials will have to show “fortitude” about getting inflation back down to target, even if it means increasing joblessness, weighing on growth and daunting investors.

“Financial markets could remain very volatile as financial conditions tighten further, growth could slow somewhat more than expected for a couple of quarters and the unemployment rate could temporarily move above estimates of its longer-run level,” she said at a business conference on June 2. “This will be painful but so is high inflation.”

Those hiccups might mean a “softish” landing is in store for the economy rather than a soft one — but both outcomes can still harm Americans’ wallets. In today’s rising rate environment, it’s important to make sure you’re parking your cash in the best place (the highest-yielding savings accounts on the market are paying more than 10 times the national average right now) and continuing to pay down debt.

If the Fed can stabilize inflation and be in the ballpark of full employment “without too much dislocation, then they’ve been successful,” Citizens Bank’s Merlis says. “But for the person who loses their job because of it, it’s not going to feel like a soft landing.”

Written by
Sarah Foster
U.S. economy reporter
Sarah Foster covers the Federal Reserve, the U.S. economy and economic policy. She previously worked for Bloomberg News, the Chicago Tribune and the Chicago Daily Herald.
Edited by
Banking editor