By Douglas Katz – 06/07/2022
Inflation is still high at 8.6%.
The Central Bank is likely to raise rates to combat inflation.
While this may weaken the economy, The Federal Reserve is still prioritizing taming inflation as key.
The Federal Reserve released their June meeting minutes yesterday and based on some specific comments, the market is bracing for another rate increase. With inflation still stubbornly high, currently pegged at around 8.6%, the Fed signaled that the central bank needs to increase rates to “restrictive” levels to slow the economy’s growth. They went on to further communicate that they “recognized that an even more restrictive stance could be appropriate” if inflation persisted and it is not likely to recede in July. After their June meeting, the Fed raised its key rate by three-quarters of a point to a range of 1.5 percent to 1.75 percent, which was the most radical single increase in nearly three decades. Based on their comments that further large hikes would likely be needed, a rate hike in July would not be a surprise. What, however, does this mean to you and how can you prepare?
Consumers should first focus on short-term and/or unsecured debt which are most impacted by changes in the Federal Funds Rate. This is primarily credit card debt, but would include any unsecured variable debt. The one outlier would be any variable mortgages, to include Home Equity Lines of Credit (HELOCs), which are more impacted by central bank moves. For the former, a lot depends on how much debt you have. Small balances or ones paid off monthly, do not really matter, but larger balances could see profound changes. Do anything that you can to determine the new payment or payments in the case of multiple creditors. If you are using disposable income to pay down a mortgage ahead of schedule or investing in anything with an expected return of less that the projected rates, now is the time to redirect that money to variable and high interest debt because you are essentially losing money. This is especially important when you are applying for a new mortgage or anything that uses a debt ratio for approval. If your overall payments change, your purchasing power may have as well and you need to know this.
This brings me to my world of mortgages. While mortgages do not directly move with the Fed Funds Rate, they will move some. In fact, mortgage rates will often move ahead of an actual rate hike based on the Fed’s comments. This is phenomenon is called pricing in the expected rate hike and lenders often do it to be able to charge more and to not get flat footed when the actual rate bump occurs. There was, for example, several intraday price increases to mortgage rates yesterday after Federal Reserve released their June minutes. This is why I tell all prospective borrowers to adjust their assumptions now as well as after the actual increase because any change can affect their purchasing power. This is not about timing the market, but rather it is about not getting an unpleasant surprise when you are making an offer, getting a loan approved or locking a rate.
The key thing to remember is that rates are cyclical. This particular cycle has been way more profound in length and size than most other ones, so it seemed apocalyptic when the trend reversed. While more pronounced, it is the same thing. The people who plan and act deliberately usually end up fine. You need to decide if you are going to be the one who rides the wave or gets drowned by it.