After much speculation, the Federal Reserve has decided to move on interest rates. Not decisively, not rashly, and maybe not at all. Instead, the Fed has announced the possibility of two interest rate hikes by the end of 2023 while at the same time explaining they might not be necessary.
Does this seem contradictory? You bet. However, what the Fed says and what the Fed means are not necessarily the same thing. The Fed has a remarkable ability to issue statements that can have numerous and conflicting interpretations. As former Fed Chairman Alan Greenspan explained in an accidental moment of candor, “I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.”
The Fed, at the moment, is dealing with three central economic threads.
First, it has been stunningly successful in helping the country avoid an outright depression as a result of the COVID-19 pandemic.
Second, despite falling official numbers, massive unemployment continues to be a problem. Industry after industry is reporting major labor shortages.
Third, prices are surging. In May,” said Rick Sharga, Executive Vice President with RealtyTrac. “existing home prices were 23.6% higher than a year earlier, according to the National Association of Realtors. Is this a short-term, transitory effect as the economy re-opens? Or, are quickly rising prices evidence that the country is about to enter an extended period with inflation rates well above 2%? At this point, there are arguments on both sides of the question.”
The Fed Reaction
How is the Fed responding to these issues? According to The New York Times, “Fed policymakers expect to make two interest rate increases by the end of 2023, the central bank’s updated summary of economic projections showed Wednesday. Previously, more than half of officials had anticipated that rates would stay near zero, where they have been since March 2020, into at least 2024. Officials now see rates rising to 0.6 percent by the end of 2023, up from 0.1 percent.”
The catch is that between now and the end of 2023 is a long time.
“There’s so much uncertainty around this,” said Fed Chairman Jerome Powell. “It’s just a unique situation that we need to see how things evolve in coming months and see how that story holds up, and act accordingly.”
Unemployment
Powell said the unemployment rate will likely fall from 5.8% in May to 3.5% at the end of 2023. If that’s right, then labor will be more in demand, wages will likely increase, employers will want to raise prices to cover bigger staffing costs, and inflation will be pushed higher. In that case, maybe the Fed will issue more than two rate hikes.
Official unemployment levels are plainly down, and yet businesses across the country are facing labor shortages. This is happening in low-wage industries such as restaurants and hospitality as well as fields with higher pay such as construction: in April, builders reported 357,000 job openings.
Powell acknowledges that the pandemic may require economic models to be revised.
The Pandemic Economy
The government spending and Fed policies that have emerged since the start of the pandemic have worked very well. But what happens as the pandemic winds down?
“The process of reopening the economy is unprecedented, as was the shutdown at the onset of the pandemic,” said Powell.
Is there a risk that inflation will remain higher than we thought? The answer, says Powell, is “yes.”
What About Mortgages
By changing the Federal Funds rate, the Fed can influence the interest levels generally charged by banks, especially the prime rate. But for the mortgage marketplace, the Fed’s importance is less direct. It can influence home equity lines of credit (HELOCs) because most come from banks, but that’s not the case with other mortgage choices.
It might seem as though mortgage rates should reflect inflation levels. This seems logical and suggests that mortgage rates will go up if the Fed wants higher interest levels generally.
The reality might be different.
During the past decade, a period marked by the lowest mortgage rates on record, you can look at the Federal Funds rate (blue), the prime rate (green), and 30-year mortgage rates (red). Mortgage rates are now below the prime rate, something not true for much of the past ten years.