Most of the Federal Reserve’s interest rate hikes may be in the rearview mirror, but U.S. central bankers aren’t yet done making it more expensive to borrow money.

The Fed’s key benchmark borrowing rate is projected to rise another three-quarters of a percentage point in 2023, hitting a 17-year high of 5-5.25 percent from its current 4.25-4.5 percent level, according to the Fed’s median projection from December.

The Fed’s projections also revealed interest rates have a greater chance of rising even higher than that. Five officials are penciling in a peak target range — often referred to as the Fed’s “terminal rate” — of 5.25-5.5 percent. Meanwhile, two additional officials see rates rising to 5.5-5.75 percent, which would be the highest level since 2001.

Just two policymakers expect rates to peak at a lower 4.75-5 percent level.

Even if the Fed’s highest forecasts come to fruition, it shows that, at most, only 1.25 percentage points of rate hikes are on the table for 2023. That’s nowhere near the 4.25 percentage points of tightening Fed officials approved in 2022 alone.

For consumers, it means the key prices they pay on mortgages or credit cards might not rise as much as in 2022, but they’ll still be among the highest levels many borrowers have seen for decades. That’s on top of growing recession odds, showing high interest rates could slam the brakes on the economy and job market. Economists in a Bankrate poll put the odds of a recession by the middle of 2024 at 65 percent.

“Not only is it a concern, but the odds favor it,” says Greg McBride, CFA, Bankrate chief financial analyst, referring to recession risks. “Look at the last three [tightening] cycles: Two of them ended in recessions, and the one that didn’t was an economic slowdown, where they had to reverse course and start cutting rates. History is not on their side.”

Fed’s rate moves depend on inflation and employment data

Where the Fed is heading — and where it’ll end up — depends on inflation and the labor market.

Even with the Fed’s rapid rate hikes, inflation has only modestly slowed, while underneath the hood, prices are still accelerating. Overall inflation has fallen 2 percentage points in just five months, but housing and services costs are still climbing, according to the Department of Labor’s consumer price index (CPI).

The labor market also still remains red-hot. Job creation is outstripping population growth, suggesting employers are adding more jobs than is sustainable, experts say. There are also about 1.7 job openings per every unemployed individual, Labor Department data shows, reflecting too few workers for too many vacant positions.

Fed Chair Jerome Powell said the can’t-be-tamed labor market might be one of the key causes of inflation — and it could make inflation more stubborn, prompting the Fed to take rates even higher.

Every Fed official said the odds favor higher inflation than lower inflation, meaning prices could rise even higher than the 3.1 percent rate they’re expecting for next year, their economic projections show.

“They may or may not be right with that risk assessment, but it tells you a lot about where they’re willing to air,” says Kathy Bostjancic, chief economist at Nationwide. “It feeds into their hawkish stance, and they’re willing to air on the side of higher interest rates because of the risk of inflation being higher.”

Companies desperate for workers often lift wages, but if they can’t find a way to eat those higher labor costs, they ultimately end up making the consumer bear the burden by increasing prices. Those higher costs are then reflected in the Department of Labor’s measure of services inflation, which is up 6.8 percent from last year, the sharpest burst since August 1982.

Just 39 percent of workers in a Bankrate September poll reported not receiving a better-paying job nor a pay raise, down from 56 percent in 2021, 50 percent in 2019 and 62 percent in 2018.

But the survey also suggested a vicious inflationary cycle could be afoot. Half of the workers who received a raise or a better-paying job say the increase didn’t keep up with inflation, Bankrate’s poll also found. That could prompt even more workers to start asking for even higher pay.

“This is a great labor market,” Powell said at a Nov. 30 address at the Brookings Institution. “It’s too great in a way, because it’s going to be adding to inflation.”

Interest rates, however, often take a while to filter through the economy, and the job market is one of the last places they end up affecting. Experts say it may take a year for the full effect of a rate hike to be realized in slower job growth and fewer job openings.

The Fed’s forecasts show unemployment hitting 4.6 percent in 2023, 0.9 percentage point higher from its current 3.7 percent level. That’s by far not the worst labor market jobseekers have ever seen (unemployment hit 14.7 percent during the coronavirus pandemic and 10 percent in the aftermath of the Great Recession), but it would no longer be a historic low.

“I wish there were a completely painless way to restore price stability. There isn’t,” Powell said during the Fed’s December post-meeting press conference. “This is the best we can do.”

With rates no longer stimulating economic growth, each rate hike from here could have an even greater effect on the U.S. economy.

“If you’re balancing risks and you get less worried about the economy slowing and more worried about inflation just staying high and getting built in to the price and wage-setting process, then you might conclude you need to move faster,” says Bill English, a finance professor at the Yale School of Management, who spent 20 years at the Fed. “Lags just make the problem harder because you have to be forward-looking and judge where the economy is going to be.”

Markets fear that defeating inflation means starting a recession

Fears of a recession are far and wide right now. One such example: The 10-year Treasury yield has been trading below the 2-year rate since early July. This inverted yield curve has long been used as a Wall Street recession indicator.

When the yield curve inverts, it shows that investors are expecting a downturn — and it also makes the flow of credit more restrictive when long-term borrowing is cheaper than short-term rates.

Markets also took a beating in 2022, as investors wrestled with those building recession risks. The S&P 500 is down nearly 20 percent so far this year as of Dec. 20, while an index tracking market volatility out of the Chicago Board Options Exchange is up 31 percent so far this year. The largest cluster of experts in Bankrate’s Market Mavens survey said the next bull market won’t begin until the second half of 2023.

Part of the anxiety about inflation all along has been that a downturn is its only cure, likely informed by markets’ bad experiences during the stagflationary-era of the 1970s and early 1980s.

Back then, the Fed manufactured what was, at the time, the worst recession since the Great Depression, hiking its benchmark borrowing rate all the way to a 15-20 percent target range. The idea that expansions don’t just die of old age has long been the lore on Wall Street.

Even more market volatility could be in store for 2023, especially considering investors and Fed officials aren’t aligned on how much higher interest rates will rise. Investors think rates will peak at 4.75-5 percent, 25 basis points lower than the Fed’s median projection for 2023, according to CME Group’s FedWatch.

They’re also expecting the Fed to quickly be forced to reverse some of those rate hikes, bringing the cost of borrowing money back down to 4.25-4.5 percent by December 2023. Fed officials, however, aren’t expecting rate cuts until 2024.

What to do with your money when rates are expected to rise and recession risks are high

The highest rates in more than a decade also mean an end to cheap money. Take steps now to prepare your finances for a new era of monetary policy, one that will mean more expensive borrowing costs down the road.

  • Keep a long-term mindset: Plunging stocks mean pain for investors, and the possibility of a recession or even higher Fed interest rates could worsen the volatility. But don’t succumb to market volatility and change up your approach. Remember, a diversified portfolio and a long-term mindset protects you through the brutalest of times in the stock market.
  • Pay down debt: Consumers with fixed-rate debt won’t feel any impact from a Fed rate hike, but you are more fragile if you have a variable-rate loan, especially if it’s a high-interest credit card. The average credit card rate hit a record high of 19.42 percent on Dec. 14, according to Bankrate data. Consider consolidating that debt with a balance-transfer card to help you make a bigger dent in your principal balance. Homeowners with an adjustable-rate mortgage or a home equity line of credit (HELOC) might want to consider refinancing into a fixed-rate loan. “You don’t want to be a sitting duck for higher interest rates on your credit card or home equity line of credit,” McBride says.
  • Boost your emergency savings: High inflation shouldn’t keep consumers from building up an emergency cushion of cash in case of emergencies or unplanned expenses. In fact, rising recession risks only underscore the urgency.
  • Find the best place for your cash: Savers can earn even more money on their cash by switching to a high-yield savings account. Many accounts on the market are offering consumers who bank with them yields above 4 percent. If you put an initial $10,000 deposit into an account with a 4 percent annual percentage yield (APY), you’d earn $400 in interest, compared with just $19 on the average savings yield of 0.19 percent.
  • Think about recession-proofing your finances: Given that plenty of risks lie ahead for the Fed, always be on the lookout for ways that you can recession-proof your finances. Along with building up your emergency fund, experts say it comes down to living within your means, staying connected with your network, identifying your risk tolerance and staying focused on the long haul if you’re an investor.

“A recession in 2023 is not a sure thing, but there’s broad agreement that the risks of one remain,” says Mark Hamrick, Bankrate senior economic analyst. “To relieve individuals, households and businesses of historically high inflation, the Fed has been prepared to accept the risk of a recession if it achieves the mandate of stable prices. Choosing from the least of two evils, it isn’t dissimilar from when firefighters trade some damage from water for fire damage.”