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The Missing Element in the Fed's Calculus on a Fourth Rate Hike

Valerie Young

The question now isn't whether the Federal Reserve will raise short-term interest rates today.

It's whether the central bank will stick with an original projection of three hikes this year, which might take rates to a range of 1.25% to 1.5%, or try for more. Equally important to consumers is what the increases will mean for student loan, credit card and mortgage balances.

Today's expected boost by the central bank's monetary policy committee, which futures trading indicates will take rates to a range of 0.75% to 1%, is "a foregone conclusion," Luke Bartholomew, an investment manager at Aberdeen Asset Management, said in a note to clients. "What's most important is the signal that they give about further rate hikes this year. We are getting to the stage where four hikes this year could be in the cards."

The Fed's plan to bolster rates that were trimmed to nearly zero during the financial crisis received a boost from the Labor Department's most recent jobs report, which showed U.S. employers adding 235,000 positions during February. 

An increase today would be only the third since 2008, and if the Fed signals it might attempt four increases this year, that would probably "rattle" financial markets, said Ryan Sweet, director of real-time economics at Moody's Analytics.

If the economy continues to outperform the central bank's expectations, "I think the Fed would likely signal a fourth rate hike" at a later date, Sweet said in a telephone interview.

A move on Wednesday of 25 basis points would increase the prime rate -- which banks charge to their most-qualified borrowers -- and affect credit card balances and home-equity lines of credit, but it would take longer for the mortgage market to see the full impact.

Still, "these interest rate hikes could add up to hundreds of dollars per month in extra fees for credit card, adjustable-rate mortgage and HELOC [home equity line of credit] borrowers," Greg McBride, Bankrate.com's chief financial analyst, wrote in a note to clients. 

"This is going to have a material impact on first-time home buyers," Barry Mione, president of Kapitall, an online investing platform targeting millennials and inexperienced investors, said in a telephone interview. "A Fed hike is very troublesome to millennials, as they are already saddled with enormous student debt, wage growth that is unremarkable, and rents at all-time highs, making it even more challenging for those looking to save for a house."

In fact, Mione says that student-loan interest rates may climb as much as 1% to 1.5%, depending on the number of rate increases.

There's roughly a 33% chance the Fed will signal a fourth hike this year, taking rates to about 1.625%, Joseph LaVorgna, chief U.S. economist at Deutsche Bank , said in a note to clients. He predicted that the Fed may project rates as high as 3.125% by 2019.

The Fed's calculus, however, may not be fulling accounting for tighter regulations that have made it more expensive for banks such as Citigroup and Wells Fargo to extend loans.

"Regulations that have boosted the amount of capital banks need to hold and have raised the proportion of their assets required to be held in liquid, lower-yielding cash" raise the cost of credit, James Glassman, senior economist for commercial banking at JPMorgan Chase, wrote in a note to clients. "As a result, the equilibrium level of the federal funds rate target might need to be lower in order to offset the regulatory cost" so that the Fed can still achieve its goals of stable economic growth and maximum employment, he said.

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