Federal Reserve's smaller interest rate hike could indicate inflation easing a bit

A smaller rate hike to kick off 2023 easily can be viewed as the Federal Reserve’s nod to the numbers indicating inflation is a bit more under control.

A rate hike of any size, though, still means that shoppers, home buyers, car buyers and others are going to pay far more to borrow than they did just one year ago. Far more.

Borrowers, after all, are getting socked in two ways. People are paying higher interest rates after the Fed’s nearly yearlong effort to stop inflation from burning out of control and they’re borrowing to buy goods and services — like cars and trucks — that often cost significantly more than they did a year ago.

The Federal Reserve’s policy committee on Wednesday, pointing to “inflation risks,” decided to raise rates by 25 basis points. The move drives the target for the short term federal funds rate to a range of 4.5% to 4.75%. It is the eighth rate hike since March 2022.

In its statement Wednesday, the Fed indicated that it anticipates that “ongoing increases” will be appropriate to combat inflation.

The Fed stated: “Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation has eased somewhat but remains elevated.”

Fed watchers follow the federal funds rate, the rate banks charge each other to borrow or lend excess reserves overnight. In early 2022, the federal funds target range had been in 0% to 0.25%. Back in 2020, the Fed brought rates to these extremely low levels to counteract the economic shock that hit at the start of the pandemic.

The Fed’s last rate hike in December was a half-point. The Fed raised rates by 75 basis points at each meeting in June, July, September and November. Earlier in 2022, the Fed raised rates by 50 basis points or 0.5 percentage points in May and by 25 basis points in March.

“The job is not fully done,” Federal Reserve chairman Jerome Powell said at a news conference Wednesday. He indicated that the expectation is that ongoing rate hikes will be appropriate because inflation remains high, even though inflation has pulled back somewhat already.

The nagging fear is that too much Fed tightening ahead could drive the U.S. economy into a recession later this year or next.

Outlook for inflation remains uncertain

The Fed’s goal is to make it less attractive to borrow and cool down spending and the economy. Whether the Fed has inflation under more control, though, is anyone’s best guess at this point.

“That’s the million dollar question,” said Justin Kimpson, senior director for the Ford Resource and Engagement Center on the east side of Detroit.

Kimpson expects that it could take until spring or summer to get a clearer picture of where inflation and prices for gas, groceries and other goods are headed.

Many families have visited the food pantry at the engagement center, he said, and sought other free services as they’re dealing with rising costs. The center, which opened in 2017, works with more than 15 nonprofit partners on-site.

“It’s affecting everybody,” Kimpson said. “Everything about life that you touch is going up.”

Jeremy Wolfe, owner of Monarch Market Cafe in Huntington Woods, said he has had to raise his prices on many items two times since opening in late 2021. He’s dealing with higher wages as many companies now pay $15 to $20 an hour. Prices skyrocketed for eggs, milk and cheese and other ingredients used to make breakfast items, like breakfast burritos. He’s now paying $60 for 15 dozen eggs — or $4 a dozen — when he used to pay anywhere from $43 to $48 a year or so ago. His store goes through 90 to 120 dozen eggs a week.

“Every industry is affected by inflation across the board,” Wolfe said. His family owned an industrial supply business where he worked in e-commerce and served as a director of data putting together databases. After the business was sold, he later spotted an empty shop in Hungtington Woods, met the owner of the building, who is now his wife. “I got a lot more out of it than I was expecting,” he said.

It’s a fine balancing act, Wolfe said, between what you can charge customers and how much you can afford to lose as prices go up when you’re trying to build a new neighborhood business.

“I’m not going to charge $8 for a cup of coffee. That’s ridiculous,” Wolfe said, adding that he charges $3 or $3.50 for regular coffee, depending on the size.

Consumers are especially cost conscious in 2023 after seeing dramatic price hikes in many areas of their lives. Many are dipping into savings to keep spending. It’s even tougher on those who have borrowed heavily on credit cards to keep up — or recently borrowed to buy big ticket items, such as a car or truck.

Consumers, of course, typically are charged interest rates that are higher than the federal funds rate if they’re pulling out their credit card, taking on a car payment or getting a new mortgage. The Fed’s actions are key because they influence other rates in the market too.

Just a year ago, the average credit card rate was 16.28%, according to Bankrate.com. Now the average is up to 19.93% — and it’s likely to head to 20.4% by midyear, according to Greg McBride, chief financial analyst for Bankrate.com.

High cost credit pinches wallets

If you’re using a credit card to make ends meet, the prices you’re paying at the grocery store and elsewhere are higher, too. It’s a double-whammy of sticker shock at the store and higher monthly payments when you get the credit card bill if you’re not paying off the balance.

Over 12 months through December, all items in the consumer price index rose 6.5% before any seasonal adjustment. On a month-to-month basis, prices overall were down 0.1% in December.

Food was up 10.4% for the 12 months through December. Meats, poultry, fish, and eggs were up 7.7% for the 12 months through December, according to the Consumer Price Index report issued Jan. 12.

New cars and trucks were up 5.9% for the 12 months through December. But used cars and trucks are down 8.8% from a year ago’s high levels.

Car buyers are getting squeezed by higher prices and higher rates, too.

The average new car loan rate has drifted higher to 8.41% now, up from 5.30% in January 2022, according to Jonathan Smoke, chief economist for Cox Automotive.

And the average used rate, he said, moved higher to 12.88% in January, up from 9.40% last year.

All things staying the same, those higher rates might translate into a 10% hike in a monthly car payment. But we’re also living at a time when car prices are up substantially. With rates and prices much higher, Smoke said, payments increased even more.

The actual average monthly payment seen on the Dealertrack platform in December was $750, which was a record high, Smoke said. That’s up from $666 a month from just a year ago — or up 13%.

Driving car prices higher

Many variables can impact the actual payments over time, such as the types of vehicles consumers are buying, prices, interest rates, the size of down payments and the incentives being offered to move cars and trucks off the lot.

 The car and truck market’s biggest problem, Smoke said, is the growing lack of affordability that’s being fueled by the high level of interest rates.

Car loan rates have reached a new 20-year high and the average price increased to a record-high $49,507 on new cars and trucks, according to the Cox Automotive/Moody’s Analytics Vehicle Affordability Index.

The Kelley Blue Book transaction price rose about 6% by December from $46,596 in January 2022.

“New-vehicle affordability in December was much worse than a year ago when prices were lower, incentives were higher, and rates were lower,” the report noted.

Smoke said car loan rates are likely to peak in the spring, following an additional rate hike at the Fed’s next meeting March 21 and March 22.

It now takes 44 weeks of median income to buy the average new vehicle with typical terms — up roughly 10 weeks or 29.5% in the past two years.

Lenders are becoming more risk averse and tightening lending standards, Smoke said, contributing to weakening demand for both new and used cars.

Consumers who are the most sensitive to rate hikes — particularly those who have lower credit scores and pay higher rates — tend to drop out of the market more quickly. Deep subprime consumers — those with credit scores below 580 — are looking at car loan rates of 19.3% for new cars now and 22.9% for used cars.

Deep subprime borrowers once made up about 10% of the new car market about four years ago but now make up less than 1%. A smaller percent of the population can afford to buy a new car.

Home buying impacted

Many people, thanks to higher rates, can no longer afford to buy the home of their dreams, either.

It’s no secret to anyone who drives around town that homes that are being put up for sale tend to be staying on the market longer. Potential buyers seem to be trying to wait for both interest rates and home prices to pull back.

The weekly average for the 30-year mortgage rate was 6.13% as of Jan. 26, according to Freddie Mac data. That’s up from an average of 3.55% a year ago.

The 30-year average had spiked as high as 7.08% in late October and early November but trended back downward as inflation cooled a bit late in 2022.

On a $200,000 mortgage, the payment would be around $1,200 — not including property taxes or private mortgage insurance — if the borrower had a 6.13% rate.

That’s up about $300 a month from a 30-year fixed rate mortgage of 3.55%. But it’s down about $125 a month from when rates peaked at 7.08%.

When will the rate hikes end?

The end of rate hikes could very well be in sight. While some analysts see two more rate hikes, one in March and another in May, ahead, others maintain that the Fed might only have another rate hike left in the tank.

Mark Zandi, chief economist at Moody’s, said he’d expect the Fed to raise rates one more time in 2023 — likely by a quarter point at the March meeting.

“Inflation is moderating and the job market and wage growth are cooling off,” Zandi said. “Recession risks are uncomfortably high for this year as the economy struggles with the higher interest rates.”

If the economy skirts a recession, as Zandi says continues to be possible, the Fed won’t begin lowering rates until the spring of 2024.

Contact Susan Tompor: stompor@freepress.com. Follow her on Twitter @tompor. To subscribe, please go to freep.com/specialoffer. Read more on business and sign up for our business newsletter.