When will the Fed stop raising rates? The time could be coming soon

·9 min read
Jerome Powell in mid speech
Credit: Images by GettyImages; Illustration by Issiah Davis/Bankrate

Raising interest rates to deliberately slow the U.S. economy isn’t a job for the faint of heart, but the next test for the Federal Reserve could make even that challenging task look simple.

After lifting interest rates last year at a pace not seen since the last time inflation soared this much 40 years ago, Fed officials must soon decide when it’s time to stop making it more expensive to borrow money.

A pause in hiking rates may be around the corner, and the debate about when to stop raising interest rates could be picking up soon. Officials in March raised rates by a quarter of a percentage point, and the largest majority of officials (10 policymakers) penciled in at least one more rate hike this year. Seven others, however, see at least two more rate hikes.

Where the Fed takes rates could have grave implications for Americans’ purchasing power, the job market, the U.S. economy — and now, banks within the U.S. and abroad. Higher rates are like a blunt instrument; they only work at cooling price pressures by slowing demand across the board. It often means something within the U.S. economy can break along with inflation.

Economists wondered whether the Fed’s tightening cycle would claim the red-hot labor market as its first victim. Then Silicon Valley Bank and Signature Bank collapsed.

[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"]

When will the Fed stop hiking rates? Watch for rates to hit this level

Economists have long expected the Fed would likely stop raising interest rates at some point in 2023, but “where” rates peak — a level known as the “terminal” rate — is actually more important than “when.”

All but one Fed official sees rates rising higher from here. The median projection among Fed officials puts interest rates in a final target range of 5-5.25 percent, suggesting the Fed will likely raise interest rates another 25 basis points before it backs down. Three officials project two more rate hikes, while another three officials project three. One policymaker sees four more rate hikes.

The median projection for the Fed’s so-called “terminal” rate didn’t change between December 2022 and March 2023 — even despite warnings from Powell earlier in March that those estimates had likely moved up.

The failures of Silicon Valley Bank and Signature Bank likely prevented the Fed from moving up its peak interest rate expectation. Powell told journalists at the March post-meeting press conference a recent tightening in credit conditions spurred by the banking crunch is likely equivalent to a quarter-point rate hike. Economists at Apollo Academy, however, project that tightening is equivalent to six quarter-point rate hikes.

Banks may get stricter with lending moving forward, especially so they can maintain liquid balance sheets to cover the needs of their now-jittery depositors. Less lending could weigh on economic growth big time. Regional and mid-sized banks facing the biggest stress also make up for half of all U.S. commercial and industrial loans, three-fifths of all residential real estate credit and four-fifths of commercial real estate lending, according to Goldman Sachs.

That potential credit crunch could do some of the Fed’s work for it, cooling inflation by design because it weighs on consumption. All in all, it may mean the Fed doesn’t have to raise rates as much.

“Policy has got to be tight enough to bring inflation down to 2 percent over time,” said Fed Chair Jerome Powell. “It doesn’t all have to come from rate hikes. It can come from tighter credit conditions. It’s highly uncertain how long the situation will be sustained or how.”

Fed officials acknowledged in their post-meeting statement from March that the recent bank failures could weigh on the economy, as well as hiring and inflation — though the full effect has yet to be seen. They also scratched a mention that “ongoing increases” will be needed to bring inflation back down to their 2 percent target, instead saying “some additional policy firming may” be necessary.

Uncertain economy, inflation and bank failures complicates Fed’s rate outlook

The difficulty with forecasting is that the U.S. economy and inflation hasn’t evolved as officials expect. In March 2022, the Fed only saw prices rising 4.3 percent from a year ago. They ended up jumping 6.3 percent, according to the Department of Commerce.

Powell reiterated the Fed would be willing to adjust its forecasts depending on how the U.S. economy evolves. In other words, a deeper banking crisis that weighs on lending more forcefully may underscore the need for fewer rate hikes. If the turbulence, however, calms and inflation remains hot, even more rate hikes may be required.

“Powell can do one of two things: Step on the gas or step on the brake,” says Robert Barbera, director of the Center for Financial Economics at Johns Hopkins University. “Except you can’t see in front of you because the windshield is covered in black paint; the only thing you can do is look in the rearview mirror. You’re stepping on the gas or the brake as a consequence of what you know was happening, rather than what you know will be happening.”

The recent banking crisis may underscore even more to the Fed that it’s time to watch and see just how much rate hikes are impacting the economy. Monetary policy can take a year, if not more, to fully impact the U.S. economy. Lenders, for example, often adjust their variable-rate loans within one to two months of a Fed rate hike, meaning it can take a while for a consumer to feel the pinch from higher borrowing rates.

Those delays have been amplified in an economy juiced up on stimulus from the coronavirus pandemic. Consumers in 2023 still had about $900 billion in excess savings, according to data from J.P. Morgan Asset Management. The Fed has also been raising interest rates at an extraordinary speed, leading to increased volatility for loan rates.

“It’s hard to be confident about your outlook,” says Bill English, finance professor at the Yale School of Management who spent 20 years at the Fed. “The best you can do is balance the risks.”

Market participants aren’t so convinced the Fed has more room to hike rates. Federal funds rate futures currently show no more rate hikes, as well as rate cuts as soon as September 2023, according to CME Group’s FedWatch.

Those differing expectations could be because investors expect a much greater economic slowdown — and possibly a recession — than the Fed. The Monday after Silicon Valley Bank collapsed, the 2-year Treasury yield plunged by the most in a single day since the stock market crash known as “Black Monday” in 1987, as market participants dumped riskier investments in a flight for safety with Treasurys.

“That pathway still exists,” Powell said, referring to the likelihood of a “soft landing.” “We’re certainly trying to find it.”

Why the Fed’s peak rate matters for consumers

Savers looking to maximize their earnings will want to pay close attention to the Fed’s terminal rate. It might indicate when yields will hit their ceiling, suggesting when it might be a strong time to lock in today’s highest yields in more than a decade with a certificate of deposit (CD). Banks’ offerings still depend on money-related supply and demand factors in addition to moves from the Fed.

As with anything in personal finance, it pays to shop around — but that’s even more true with your savings in a rising-rate and high-inflationary environment. Banks more than doubled their payouts last year, while individuals have seen even bigger earnings with high-yield savings accounts.

Figuring out when the Fed will stop hiking rates is also important because of the debate that often follows: When to start cutting. Fed officials, however, don’t think it’ll happen as quickly as investors.

“We think that we’ll have to maintain a restrictive stance of policy for some time,” Powell said in December. The Fed would want to be “confident” that inflation is moving down to its 2 percent goal in a “sustained way” before making it cheaper to borrow money, Powell has said.

Borrowers will certainly be holding their breath for that moment, especially would-be homebuyers who have been priced out of an already expensive housing market long before officials first started hiking rates at a breakneck pace. The 30-year fixed-rate mortgage more than doubled in 2022, hitting a 20-year high of 7.12 percent on Oct. 28. It’s since fallen to 6.66 percent as of March 22, according to Bankrate data.

The drop illustrates that mortgage rates certainly don’t have to wait for the Fed’s word to start falling. Influencing the key home loan even more than the Fed is the 10-year Treasury yield. That key rate and then the 30-year fixed-rate mortgage could fall like dominoes if investors turn to thinking inflation has peaked — and instead, start to fret about a recession or a credit crisis.

A Bankrate survey of economists showed a 64 percent chance of a recession at some point in 2023.

The Fed isn’t shy about the consequences of higher rates. They’ve stopped short of saying they expect a recession but acknowledge pain may lie ahead. Policymakers saw unemployment rising to 4.5 percent by the end of 2023 in their last projections from March, a 0.9 percentage point gain from its current level of 3.6 percent. That’s never happened without the U.S. economy being in a downturn.

“No one really knows where it’s going to end. The path is very narrow, and the Fed has to pull a rabbit out of their hat [to avoid a recession],” says Ryan Sweet, chief economist at Oxford Economics. “They’re going to break inflation no matter what. The risk is that they do too much.”

[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"]