Fed raises interest rates for the 10th time: What it could mean for recession concerns

Just a year ago, most consumers had no idea they'd witness such a startling string of rapid fire interest rate hikes. Or keep paying so much for everything they're buying.

Inflation turned into a nonstop headache once it spiked at 9.1% last June — the highest level in 40 years. The Federal Reserve wasn't going to get the job done with just a few moves. But, folks, we're running out of hands to count all those rate hikes here.

On Wednesday, the Federal Reserve rolled out its 10th interest rate hike since March 2022. The Fed nudges up rates when it wants to drive up the cost of borrowing and cool down spending to address inflation. And the Fed came late to the party to tackle the worst inflation in decades — so the rate hikes ended up being fast and furious.

The Fed's short-term benchmark rate went up Wednesday by a quarter of a percentage point. The new target for the short-term, federal funds rate sits at a range of 5% to 5.25%.

Rates skyrocketed from virtually zero in early 2022 to more than 5% now.

One has to go back to 2006 — or some 17 years — for when the Fed last pushed the federal funds rate as high as 5.25%. The Fed later began cutting rates in the fall of 2007, shortly before the Great Recession began, and kept cutting through the end of 2008.

The Fed on Wednesday gave a nod to notable bank failures recently but indicated that another rate hike was warranted, noting that inflation risks remain a concern. Yet, the Fed left room for a possible pause to rate hikes in the future.

"The U.S. banking system is sound and resilient," according to the Fed statement Wednesday.

"Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain."

The statement said the Fed was "prepared to adjust the stance of monetary policy as appropriate if risks emerge."

Will the Fed stop raising rates?

It's possible, some argue, that this is it for the Fed. The big worry is that more rate hikes on top of slowdowns in parts of the economy and a few shocking bank failures in the past two months might only shove the U.S. economy into a full-fledged recession.

After all, inflation is cooling down, hitting 5% year-over-year in March.

Banking is putting more people on edge and leading to tighter credit. California-based Silicon Valley Bank and New York-based Signature Bank collapsed in March. Then days ago, regulators seized San Francisco-based First Republic Bank and struck a deal to sell most of First Republic's assets Monday to the country's biggest bank, JP Morgan Chase. First Republic saw a bank run in March, losing $100 billion in deposits, after the Silicon Valley Bank debacle.

So far, the banking turmoil has been limited to a small group that generally had poor risk management practices, relied on a large base of uninsured deposits and had made bad bets on where interest rates would be headed.

The Fed knows that anxiety is building.

Consumers are increasingly feeling the squeeze as they pay more for rent, housing, food and other goods. Right now, many can continue to spend, thanks to the strong job market, higher wages and an ability to borrow or tap into savings.

But that scenario isn't likely to continue. High interest on credit cards — now an average of 20.23% compared with 16.4% a year ago — means consumers can't really afford to keep buying everyday essentials or much else by pulling out the plastic.

The worst place to be is holding a stack of credit card debt when these super high rates aren't likely to fall even when the Fed stops its rate hikes.

Retailers say some consumers already are cutting back spending as if we were in a recession — even though the economy has kept growing.

The U.S. economy grew at a tepid 1.1% in the first quarter, according to economic data released by the U.S. Commerce Department on April 27. Some economists had been expecting growth in the 2% range. Consumer spending had held up but economists warn that it has been weakening recently.

We're hearing more talk of rolling recessions.

Sung Won Sohn, a finance and economics professor at Loyola Marymount University, said slowdowns that hit specific industries or communities are already taking place.

Rolling recessions, he said, exist in housing, parts of the tech sector and are likely to hit the auto industry in the future. A rolling recession is when industries or communities get hit by a slowdown and the entire U.S. economy doesn't slump all at once.

Downturns started with sharp declines in new home construction that hit last spring and summer. A spike in mortgage rates in October triggered a drop in home sales. Sohn's optimistic that the troubles in housing could be in the process of bottoming out.

Parts of the tech sector, Sohn said, are in recession as both consumers and businesses cut back spending. Many of the tech layoffs, Sohn said, are the results of an anticipated recession.

As the chip shortages eased, more cars ended up on dealer lots in recent months and consumers who had delayed shopping fueled auto sales in spite of higher interest rates and higher car and truck prices.

"Auto sales have rebounded from the depressed level during the pandemic," Sohn said. But he warned that auto sales aren't likely to keep going strong.

"Sooner or later, Detroit will join the rolling recession."

Inflation, Sohn said, is eating away at the purchasing power of many consumers. Businesses are already cutting back on spending on equipment and other goods.

"By the end of the year, most sectors of the economy will have gone through a recession taking its turns," Sohn said.

If the Fed keeps raising interest rates — and Sohn expects another quarter point hike at the next Fed meeting June 13 and June 14 — he said some sectors could experience a longer recession or experience a recession twice in a couple of years.

Sohn said he'd prefer to see the Fed pause from here, stop raising rates for now and take a wait and see approach.

Detroit and car buyers likely to feel the squeeze

Jonathan Smoke, chief economist for Cox Automotive, said deteriorating economic circumstances could prevent the Fed from raising rates in June or July.

Already, consumers who have lower incomes and lower credit quality dropped out of the new vehicle market. They're being pushed out by the combination of higher rates, tighter credit, and high prices for cars and trucks.

Smoke said new vehicle supply is up about 70% from a year ago, which is a good thing. But other factors are putting a damper on sales.

Given uncertainty, credit could tighten further. Some consumers with less than perfect credit could face high rates — and be required to put more money down on a car or truck. Some lenders might not approve car loans for extremely long terms, which might keep a payment more manageable but carry more risk.

"This summer may be brutal for its impact on consumer confidence and credit conditions," Smoke warned, "and that does not bode well for retail vehicle demand."

While he's hopeful that the economy can make it through rough patches ahead, Smoke said the Fed would need to make it clear that it plans to pause its rate hikes for some time.

Is a recession a done deal?

The probability of a classic, across-the-board recession by the end of this year or next seems to be going up, according to several economists.

Smoke puts the recession risk through 2024 to be about 60% — or more likely than not. "The Fed does add to that risk," he said, "especially if we see more rate hikes that could cause more challenges to the banking system and lead to more credit tightening."

The next few months, he said, will be pivotal to a recession materializing or not later in the year.

Stuart Hoffman, senior economic adviser for the PNC Financial Services Group, maintains that a mild recession might begin in the upcoming third quarter and run anywhere from six months to nine months sometime into 2024, which would be shorter than a more typical yearlong recession.

Why everyone is watching the Fed

Interest rates had been driven to exceptional lows during the pandemic, as the Fed sought to minimize the economic shock when COVID-19 cases spread across the country in 2020.

Those who borrowed a few years ago and locked in a low rate mortgage or car loan, for example, are still benefiting.

The Fed began raising interest rates about two years after the pandemic began when many said the U.S. economy was already overheating from stimulus cash. The theory had been that inflation was "transitory" and that the price hikes were only a temporary part of the picture after the pandemic. Instead, inflation proved to be quite stubborn.

The impact of the latest quarter point hike hits the hardest for borrowers who are carrying balances on credit cards or those who borrowed using home equity lines of credit.

"Those borrowers tend to have variable rates pegged to the prime rate plus the lender’s profit margin," said Ted Rossman, senior industry analyst for CreditCards.com and Bankrate.com.

Consumers will see the latest rate hike, he said, reflected on their new and existing balances within a month or two for credit cards and home equity lines of credit.

The Fed makes adjustments directly to the federal funds rate to influence borrowing patterns. The federal funds rate is what bankers charge when making overnight loans to one another to meet regulatory requirements relating to reserves on hand.

As wonky as that sounds, the federal funds rate hits everyday consumers because it influences other interest rates, such as the prime rate. The prime rate was 3.25% before the Fed started raising rates last year, but soared to 8% by March after the last rate hike. The prime rate is generally the federal funds rate plus 3 and will go to 8.25% after Wednesday's rate hike.

“A quarter-point hike by the Fed this week would translate into a quarter-point hike in credit card rates, home equity lines of credit, and other variable rate consumer and small business loans," said Greg McBride, chief financial analyst for Bankrate.com, which lists rates on various products.

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Here's a look at some other rates:

New car loans

The average rate being offered on a five-year new car loan was a mere 3.98% as of March 9, 2022. It has climbed to 6.58% currently, according to Bankrate.com. Auto loan rates are the highest in about 12 years.

"Existing car loans tend to be fixed rates, so the impact on auto lending is focused on new borrowers," Rossman said. Auto loan rates often track five-year Treasury rates, he said, which are influenced by the Fed and other market factors.

In many cases, consumers are paying far higher rates to buy a new or used car, based on the quality of their credit. The average new rate for those who bought cars in March almost reached 9%, Smoke said, while the average used car rate hit 14%. Rates have trended a bit down since then and some expect that automakers will need to offer more incentives on interest rates in 2023.

The average new rate in April, Smoke said, was 8.8%, up 3 percentage points from a year ago. The average used rate in April was 13.5%, up 3.5 percentage points from a year ago.

"If we avoid a recession," Smoke said, "it is possible that we are near the peak in rates and consumers could see lower rates later in the year."

More: Record number of buyers opt for $1,000+ car payment

Mortgages

The average rate on a 30-year fixed mortgage was 4.14% in early March 2022. It's now 6.48%, based on Bankrate.com's data.

McBride said the increase in mortgage rates since last year has had a similar effect on affordability as a 30% increase in home prices would have had.

1-year CD

The average rate on a one-year CD was 0.19% in early March 2022. It's up to 1.68% now, according to Bankrate.com. But those who shop around can find rates of 4% or higher for promotions on short-term CDs at local banks and credit unions. Online only banks are offering around 5% on short-term CDs.

Savers didn't see a sizable boost in interest rates early in the game after the initial Fed rate hikes last spring and summer. Big banks are often slow to raise rates on deposits, especially when deposit levels remain high, according to Ken Tumin, founder of DepositAccounts, which is part of LendingTree and tracks and compares bank rates.

But lately, several big banks have become more competitive with CD rates as they try to hold onto deposits once savers began worrying in March about the health of banks in light of the recent failures.

Even Apple generated some buzz when on April 17 it began offering a 4.15% annual percentage yield for an Apple-branded savings account with its partner Goldman Sachs Bank. The account is available only to Apple Card customers.

If the Fed stops raising rates, savers could see rates on some savings accounts and CDs fall fairly quickly, depending on the bank or credit union.

Savers need to understand that deposit rates vary widely — even sometimes within the same bank or credit union. You might get a far better rate on a 13-month or 14-month CD than if you simply sign up for a one-year CD at the same bank.

Some say CD rates could be nearing a peak here — and now might be a good time to lock in a rate. "The best rates should remain high for a while, though," Rossman said.

Even if the Fed is done raising rates, borrowing across the board will continue to be costly for much of 2023 after 10 rate hikes in the past year.

If inflation comes down significantly later this year, some say, the Fed could cut rates in 2024, or maybe even as early as September. And if a U.S. recession hits hard, the Fed will have to pivot and cut rates swiftly to shore up the economy, instead of trying to cool things down.

Contact Susan Tompor: stompor@freepress.com. Follow her on Twitter @tompor. To subscribe, please go to freep.com/specialoffer.

This article originally appeared on Detroit Free Press: Fed hikes interest rates amid slow economy growth, recession fears