Credit Sesame discusses the Federal Reserve interest rate policy outlined in the December 13, 2033 announcement.
The Fed announced on December 13 that it decided not to raise interest rates at this last meeting of 2023,. The stock market jumped up 500 points. Commentators hailed it as a turning point in monetary policy.
Why was doing nothing seen as such a big deal? Should you be joining those who are celebrating the Fed’s inaction?
The decision to keep interest rates steady may not yet qualify as a new interest rate policy (interest rates may yet rise again) but there could be benefits for consumers, albeit not immediately.
A possible end to an extended rising rate campaign
The decision not to raise rates again in 2023 contradicted what the Fed had previously signaled. In economic projections released in September, the Fed indicated it expected Fed rates to end 2023 at 5.6%. That would have required one more rate hike before the end of the year.
That rate hike would have been the latest in a series of 11 rate hikes totaling 5.25% beginning in March 2022. Rate hikes are unpopular with investors and consumers alike. For investors, higher rates generally reduce the present value of future earnings on their investments, which tends to decrease stock and bond prices.
For consumers, higher interest rates mean they pay more to borrow money. This hits especially hard at a time when US consumers have a record amount of debt.
One fewer rate increase than originally expected might not seem like a big deal. But along with announcing no rate hike at its latest meeting, the Fed also released a new set of economic projections. These projections signaled a turning point in the Fed’s monetary policy (and associated interest rate policy).
Compared with the Fed’s previous projections, the new outlook calls for interest rates to fall more swiftly over the next two years than previously thought. This would provide a quicker boost for investors and faster relief for consumers.
In the long run, this will be meaningful only if the Fed has succeeded in calming inflation. The new economic projections show more optimism that this is the case. Inflation has cooled more quickly over the past couple of months than the Fed had expected in its September projections. The new projections show inflation falling faster next year than previously thought.
Why investors jumped for joy
When the Fed announced the outcome of its latest meeting, the Dow Jones Industrials average jumped by more than 500 points. It followed that with a surge of over 150 points the next day. That represents a gain of about 1.8% in just two days. If that doesn’t sound particularly impressive, consider that based on the Dow’s total market value of nearly $11.8 trillion, 1.8% represents a gain of over $200 billion in under 48 hours. And that’s just the 30 stocks that make up the Dow. The broader S&P 500 and Nasdaq indexes also showed big gains immediately following the Fed’s news.
One reason for this is the way stocks are valued. Rising interest rates diminish the present value of future earnings. Conversely, falling interest rates increase the value. The news that the Fed is skipping a planned rate hike and plans to reduce rates next year led investors to place higher value on stocks. For similar reasons, bonds also get a boost from falling rates.
Besides improving how future earnings translate to market prices, the prospect of lower rates also made investors more optimistic about the size of those earnings. High interest rates act as a drag on economic growth. The economy already faces some other headwinds going into 2024. For millions of consumers, the resumption of student loan payments will make less money available for spending. Also, in the face of higher credit risk, lenders are tightening lending standards, making it tougher for people without excellent credit scores to get loans and credit cards.
If rates start to fall in 2024, it will ease the burden of consumers who rely on credit card debt. That may not prevent economic growth from slowing, but it could save the economy from tipping over the edge into recession.
Consumers should still expect to pay a price in 2024
There is reason to cheer the prospect of lower inflation and interest rates next year, but both will still cost consumers plenty in 2024.
Inflation prediction
The Fed projects a slower pace of price increases next year, but they still expect prices to increase by more than their 2% inflation goal.
The expectation is for price increases to slow and not for prices to come down. So, budgets stretched by high inflation over the past couple of years will have to be adjusted to fit future prices.
Interest rate policy
For now, the Fed has stopped raising interest rates. However, it hasn’t yet started lowering them and may not do so until well into 2024.
Americans with credit card balances will start the new year paying high rates on their balances. The average rate charged on credit cards is 22.77%. That’s the highest level since the Fed started keeping credit card rate records in 1994. Also, even after rates start to come down, previously existing balances may continue to be charged higher rates for some time.
Is the new interest rate policy just the beginning?
It’s important to be realistic about what to expect from rate cuts. Rates may come down from today’s levels but never return to where they were a few years ago.
For the 14+ years from April of 2008 through August of 2022, the Fed funds rate never once got above 2.5%. That may have come to seem like normal, but those low rates were the exception rather than the rule. Over the past 50 years, the Fed funds rate has averaged 4.8%. 4.8% is just half a percentage point below today’s 5.3% Fed funds rate. For all the talk of high interest rates, they are closer to “normal” than they have been for a long time.
Rates could fall further than the historical norm if the Fed successfully drives inflation down to 2.0%. Over the past 50 years, inflation has averaged almost twice that, at 3.9%. The 4.8% average Fed funds rate is typically 0.9% above the inflation rate. If this is the norm and inflation falls to 2.0%, the Fed funds rate could drop to 2.9%.
While that would be a substantial drop from today’s rate, it wouldn’t be anywhere near as low as rates were from 2008 to 2022. Consumers and investors need to reset their expectations accordingly.
If you enjoyed Who benefits from the Fed’s interest rate policy in December 2023? you may like,
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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.
