How the Fed affects credit cards
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The Federal Reserve is not done fighting inflation, and credit card holders are likely to see their variable interest rates head higher as a result.
The central bank announced at its March 2023 meeting that it will raise its target interest rate range by a quarter percentage point, to the 4.75 percent to 5 percent range. This follows a series of rate raises that started in March 2022, lifting up the Fed’s target rate from 0 percent.
However, the Fed also acknowledged that the failures of Silicon Valley Bank and Signature Bank in March will likely filter through the economy and have a slowing effect on credit availability, employment and inflation, which will aid the Fed’s goal of cooling down the economy.
And Fed officials’ forecast for an appropriate Fed funds rate for 2023 is now as high as 5.9 percent (up from 5.6 percent when they last made their projections). This heralds additional rate hikes this year.
That means if you’re tapping into your credit card and don’t pay off the balance when it’s due, you may pay more interest than you bargained for. With higher interest rates, it’s smart to be strategic about your credit card debt.
Although inflation has been moderating in recent weeks, with the Consumer Price Index up 6.0 percent over the year in February (the lowest yearly increase since September 2021), the Fed is still on the alert. In the last year, inflation has been running at its highest level in more than 40 years, and the Federal Reserve will remain vigilant until it is convinced it has slayed the beast.
In 1980, inflation under Fed Chair Paul Volcker reached 11 percent. With that lesson in mind, the Fed is now focused on acting to quell inflation so that consumers and businesses don’t anticipate higher inflation down the road.
Pandemic-related effects led to inflation
The Fed’s actions are aimed at combating the inflation that surfaced post-pandemic. With supply chain disruptions and stimulus efforts provided during the pandemic, along with the impact of the war in Ukraine (which affected the price of oil and other commodities), stoking inflation, the Fed is now focused on raising its targeted interest rate to combat fallout from inflation that has proved to be stickier than the Fed expected.
After the coronavirus pandemic began in 2020, the Fed initiated rate cuts that brought down its target interest rate to practically 0 percent. This low rate was aimed at spurring consumption and business investment in order to keep the economy’s wheels greased as it recovered from the crisis.
The Fed also stepped in to purchase mortgage-backed securities and Treasury securities, which, too, had the effect of pumping money into the economy and lowering interest rates. It took additional measures as well to prevent financial markets from freezing up.
Now, in what is known as quantitative tightening, the Fed is also gradually shedding its balance sheet of the securities it acquired. This action will suck up money from the economy and further aid the Fed’s agenda by pushing up interest rates due to the reduced money supply.
Employment and inflation goals
The Fed’s actions are guided by its dual mandate of managing both employment and inflation to optimize economic performance. Its aim is to shoot for maximum employment while letting inflation run at 2 percent in the long run, making for price stability.
Back in 2020, the Fed decided it would keep rates low — even as employment rose — to make the labor market more inclusive and allow even disadvantaged groups to get jobs, keeping in mind the lessons learned after the 2008 recession (when inflation did not rise even though employment continued to grow). It seemed the Fed would not start raising rates until 2023, but as inflation concerns surfaced, the central bank started its tightening cycle earlier in March 2022.
Considering that the pandemic-influenced inflation continues to linger and has been further fueled by the war in Ukraine, the Fed is now focused on bringing inflation down so that expectations for higher inflation don’t get entrenched in the minds of consumers and businesses.
The good news is that the labor market remains strong, even as the Fed has raised its target rate multiple times since 2022. In February, the U.S. economy added 311,000 jobs, and unemployment was at 3.6 percent.
Inflation expectations have declined
It seems consumers are not wedded to the idea that current high inflation levels will continue to stick. A consumer survey by the Federal Reserve Bank of New York finds that respondents’ median inflation expectations for the year ahead were at 4.2 percent in February. And for the three-year ahead period, inflation expectations were at 2.7 percent.
In Congressional testimony, before the Silicon Valley Bank failure, Fed Chair Jerome Powell was hawkish, focused on fighting inflation. He said, “Although inflation has been moderating in recent months, the process of getting inflation back down to 2 percent has a long way to go and is likely to be bumpy. As I mentioned, the latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated.”
The Fed policy statement released after its March meeting noted that the Fed will continue to monitor incoming data such as “financial and international developments,” along with inflation and employment data, to determine its future course of action.
Impact on credit card interest rates
What all this means for cardholders is that you are likely to see your variable card rates increase. These rates are tied to the prime rate, to which issuers add a markup to arrive at your card’s interest rate. The prime rate, in turn, is based on the Fed’s target interest rate. This means that when the Fed starts hiking its target rate, the prime rate will also go up.
And when the prime rate goes up, variable interest rates soon follow. In fact, interest rates on credit cards continue moving up, with the national average APR at about 20 percent as of mid-March 2023, up from 16.34 percent in March 2022.
That means you should start managing your credit card balances more strategically. If you carry a balance, make plans to pay it off. If you will be carrying a balance for a while, you could transfer it to lower-interest options, such as a 0 percent interest balance transfer offer.
You might also consider taking out a personal loan to pay off your credit card if that offers a better deal for you. Home prices have been on a tear in recent years, and homeowners could even weigh getting a home-equity loan to pay off credit card debt.
The bottom line
The Fed is continuing the process of fighting inflation, hiking up its target rate by another 25 basis points in March. And it seems the central bank is not quite done yet. Since variable credit card interest rates are tied to the prime rate, which is based on the Fed funds rate, consumers should be prepared for their variable interest rates to continue to increase, too. You should take strategic action to avoid higher interest rates.