Image by Getty Images/Illustrations by BankrateMost of the Federal Reserve’s interest rate hikes may be in the rearview mirror. The question now: How many more increases can officials sneak in before the U.S. economy breaks?

After spending last year raising interest rates at a speed unmatched since the 1980s, Fed policymakers are taking a different approach in 2023: hiking interest rates at a slower and more deliberate pace. U.S. central bankers in March lifted interest rates by a quarter of a percentage point, bringing its benchmark borrowing rate to a new 4.75-5 percent target range. Rates haven’t been at this level since the mid-2000s.

But that smaller move wasn’t without bumps in the road. After downshifting to quarter-point moves in February, the Fed was gearing up to raise interest rates by a larger half point in March as inflation remained more stubborn than expected. That, however, was before two major bank failures rocked financial markets, creating stability concerns and risks of knocking the economy off course.

Experts say those bank failures are unlike what happened during the 2008 financial crisis, but they highlight just how many cracks in an otherwise-sound system can form when inflation — and interest rates — soar much higher and faster than anyone could’ve predicted.

Even Fed officials now note there’s uncertainty. Only one Fed official projects the Fed won’t hike rates anymore this year, while the majority (10 officials) see just one more rate increase. Three project two more rate hikes, another three project an extra three rate hikes, while one policymaker sees four more rate hikes.

Fed’s future moves depend on inflation, employment — and banking stressThe collapse of Silicon Valley Bank and Signature Bank earlier this month shows the Fed has new concerns to manage: financial stability and price stability.

Higher interest rates are getting some of the job done, with consumer prices in February rising 6 percent from a year ago — down more than 3 percentage points from its June peak of 9.1 percent. That’s still, however, three times the Fed’s preferred 2 percent inflation target.

Making matters worse, inflation hasn’t been slowing as quickly this year as officials expected. Policymakers upgraded their inflation forecasts for the year in fresh economic projections from March. Powell said those hot prices are underscoring the need for monetary policy to remain tight.

“We are committed to restoring price stability, and all of the evidence says that the public has confidence that we will do so,” the chief central banker told journalists in March. “It is important that we sustain that confidence with our actions as well as our words.”

Policymakers, however, noted in their post-meeting statement from March that recent banking stress is likely to weigh on the economy — though the full extent is uncertain.

Financial conditions have tightened since the March bank failures. Stock markets have been bumpy, particularly for banks. A measure of volatility in the bond market rose in March to the highest level since 2009, pointing to difficulties in trading the assets that have long been regarded as the most liquid in the world. Along the way, banks may slow lending to businesses and consumers to make sure they have enough cash to meet their depositors’ needs. Less lending and difficulties in securing credit could do some of the Fed’s work for it by cooling demand — and along with it, inflation.

Powell mentioned at the March press conference that the recent credit crunch is likely equivalent to a quarter-point rate hike. Some experts, however, say it could be worth more than that. Economists at Apollo Academy, for instance, project that tightening is equivalent to six quarter-point rate hikes.

Some of the volatility subsided as March came to a close, with an index tracking regional bank stocks jumping 6 percent between March 24-29. But another bogeyman around the corner could quickly come to crash the party — and interrupt the Fed’s plans to keep raising rates.

[sc code="block_quote" quote_text="If the financial system remains stable, this likely isn’t the last rate hike. But if another shoe drops and conditions deteriorate, the question becomes how soon the Fed will reverse course and begin cutting rates – aggressively." source="Greg McBride, CFA, Bankrate chief financial analyst" image="https://www.bankrate.com/2023/03/17104228/greg-mcbride.png"]

Investors aren’t so certain the Fed will be able to lift rates anymore from here. Market participants are betting the Fed’s benchmark will hold steady in its 4.75-5 percent target range — until the fall, when the Fed may be forced to cut borrowing costs, according to CME Group’s FedWatch. Traders see 50 basis points worth of cuts by the end of the year, the tool shows.

The differing expectations are likely tied to the Fed’s economic outlook. Fed officials aren’t expecting to slash interest rates until 2024 — and in March, they suggested they see just 75 basis points worth of cuts, rather than the previously projected 100 basis points worth of rate cuts.

“Participants don’t see rate cuts this year,” Powell said in March. “They just don’t.”The more hawkish stance goes back to where policymakers see inflation heading. Price pressures are projected to hold above the Fed’s 2 percent target through at least 2025. The largest majority of Fed officials also showed they see the risks to both core and headline inflation as weighted to the upside, even if a growing share of officials are starting to see those risks as balanced.

The U.S. economy is also seen as growing — albeit more modestly — over the next two years.

“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. “They’re willing to air on the side of higher interest rates because of the risk of inflation being higher.”

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. A year ago, rates were still at near-zero percent.

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 recessionLong before any banks failed, Fed watchers feared U.S. central bankers might do too much in their quest to defeat inflation. Experts in Bankrate’s first-quarter Economic Indicator survey put the odds of a recession for 2023 at 64 percent.

Another example of those recession fears: The 10-year Treasury yield has been trading below the 2-year rate since early July 2022. This inverted yield curve has long been used as a Wall Street recession indicator.

It’s more than just a measure of fear. 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.

The recent bank failures illustrate a flipped yield curve can cause some real damage for some of the world’s biggest financial institutions. Silicon Valley Bank, which was the 16th largest financial firm in the U.S., had to take a $1.8 billion loss selling a portfolio of Treasury securities that it purchased when interest rates — and yields — were low.

Throughout history, the Fed has only been able to defeat this large of an inflation surge by putting the U.S. economy through a recession. During the stagflationary-era of the 1970s and early 1980s, officials hiked its benchmark borrowing rate all the way to a 15-20 percent target range. It got the job done, but only by bringing the U.S. economy to a grinding halt — kickstarting what was, at the time, the worst recession since the Great Depression.

“Not only is it a concern, but the odds favor it,” McBride says. “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.”

What to do with your money when rates are expected to rise and recession risks are highMost of the Fed’s rate hikes may be over, but each increase means higher borrowing costs for consumers — including on a credit card, personal loan, auto loan and more. Those borrowing costs are also unlikely to fall until the Fed cuts rates.

The highest rates in more than a decade also mean an end to cheap money. Take steps now to prepare your finances for this new era of monetary policy, one where borrowing costs are unlikely to return to record-low levels anytime soon.

Keep a long-term mindset: Differing expectations about what the Fed could do with rates in the months ahead could lead to more market volatility. 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 your approach. Remember, a diversified portfolio and a long-term mindset protect you through the most brutal times in the stock market.

Pay down debt: Consumers with fixed-rate debt such as a mortgage 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 keeps breaking records, hitting 20.05 percent as of March 22, 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 a cushion of cash in case of emergency 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 $23 on the average savings yield of 0.23 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.

“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,” says Mark Hamrick, Bankrate senior economic analyst. “Choosing from the least of two evils, it isn’t dissimilar from when firefighters trade some damage from water for fire damage.”

[sc code="taboola_pixel_script" campaign_id="1539782"] [sc code="conversion_pixel" src="https://trc.taboola.com/1539782/log/3/unip?en=barclays_buttonclick" widget_id="1339f858-72b4-42e0-a08f-be6c80a3fc53" selector=".StoryblokContent a, .SponsoredBanner a"]
Click Here To Get Funded!