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Consequences of an Unnecessary Interest Rate Hike

·3 min read
AUDINDesign / Getty Images/iStockphoto
AUDINDesign / Getty Images/iStockphoto

While the Federal Reserve said it would keep rates steady until 2023, albeit planning to raise them earlier in the year at its much-anticipated Federal Open Market Committee meeting last month, Fed officials seem increasingly divided as to when the hike would start.

See: Fed Behind on Inflation and Risking Recession, International Finance Expert Says
Find: Interest Rates Aren’t Going Anywhere Yet — How Stagnation Benefits Homeowners and Banks

In its quarterly projections published after the meeting, 13 of 18 officials saw a likely need for higher rates by the end of 2023, with seven of them seeing a need to begin raising rates as soon as next year, according to Bloomberg. This represents a notable shift from March’s projections, when 11 of 18 officials expected there would be no need for rate increases before 2024, and only four thought tightening would be needed in 2022, according to Bloomberg.

Some observers are warning of the unnecessary consequences and issues an earlier rate hike could trigger, including slowing down the economic recovery and putting pressure on home prices.

Jay Hatfield, founder and CEO of Infrastructure Capital and portfolio manager of PFFA, tells GOBankingRates that if the Fed surprises the market with faster than expected taper of quantitative easing, or even a rate hike, it could limit the economic recovery as the stock market would likely decline 10-20% with negative implications for financial conditions, consumer spending and business investment.

“We do expect inflation to continue to surprise to the upside, but the Fed’s abandonment of its rigid 2% inflation target and newfound focus on its dual mandate, make a premature tightening unlikely,” Hatfield adds.

The Fed indeed also significantly raised its inflation forecast, as according to meeting participants’ projections, the inflation forecast is up 3.4% from 2.4% in March, based on Fed data.

Jonathan Wiley, vice president and head of investments at Arch Global Advisors, agrees, telling GOBankingRates that if the Fed decides to hike too quickly, there is a risk of them choking off the rebounding economy.

“While there is clamoring for interest rates to rise soon to stem off inflationary pressures, we take the position that any price increases will only be transitory, as there are base effects. Falling yields on the 10-year of late would indicate as much. Further large, stimulative government expenditures could possibly change our opinion. However, progress remains slow in Washington. There is a delicate [Nik] Wallenda-like balancing act taking place, failing to signal properly can spook the markets as well,” he adds.

Another potential consequence of the Fed raising rates is that it could have a significant impact on the housing market. According to Danielle Hale, Realtor.com chief economist, a single percentage point can add more than $100 to a homeowner’s monthly payment and tens of thousands of dollars over the life of a 30-year loan, depending on the rate and size of the mortgage.

“That could further slow down the market as more potential buyers could simply be priced out,” she writes on Realtor.com.

See: What Would the Benefit of Raising Interest Rates Right Now Be?
Find: How Interest Rates Affect Your Wallet and the Bigger Economic Picture

The sentiment is echoed by Tim Isgro, CIO at Reverse Mortgage Investment Trust, who tells GOBakingRates that the Federal Reserve is still of the view that inflation today is transitory and that they will begin raising short-term interest rates in 2022.

“If they did so, and longer-term mortgage rates followed suit, that would make home-buying more difficult, as buyers contend with higher potential mortgage payments, lowering their home purchase budgets.”

He adds that in turn, it would put pressure on home prices.

“Moreover, with the spate of higher home prices over the past year, housing now near its seasonal peak for the year, and some evidence for inflation being transitory, like lumber prices decreasing over the past two months, we may be in for a cooler period of home price growth in the short-term,” he says.

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This article originally appeared on GOBankingRates.com: Consequences of an Unnecessary Interest Rate Hike