Tag: Federal Reserve Bank

Powell reinforces position that the Fed is not ready to start cutting interest rates

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Federal Reserve Chair Jerome Powell on Wednesday reiterated that he expects interest rates to start coming down this year, but is not ready yet to say when.

In prepared remarks for congressionally mandated appearances on Capitol Hill Wednesday and Thursday, Powell said policymakers remain attentive to the risks that inflation poses and don’t want to ease up too quickly.

“In considering any adjustments to the target range for the policy rate, we will carefully assess the incoming data, the evolving outlook, and the balance of risks,” he said. “The Committee does not expect that it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.”

Those remarks were taken verbatim from the Federal Open Market Committee’s statement following its most recent meeting, which concluded Jan. 31.

During the question-and-answer session with House Financial Services Committee members, Powell said he needs “see a little bit more data” before moving on rates.

“We think because of the strength in the economy and the strength in the labor market and the progress we’ve made, we can approach that step carefully and thoughtfully and with greater confidence,” he said. “When we reach that confidence, the expectation is we will do so sometime this year. We can then begin dialing back that restriction on our policy.”

Stocks posted gains as Powell spoke, with the Dow Jones Industrial Average up more than 250 points heading into midday. Treasurys yields mostly moved lower as the benchmark 10-year note was off about 0.3 percentage point to 4.11%.

Rates likely at peak

In total, the speech broke no new ground on monetary policy or the Fed’s economic outlook. However, the comments indicated that officials remain concerned about not losing the progress made against inflation and will make decisions based on incoming data rather than a preset course.

“We believe that our policy rate is likely at its peak for this tightening cycle. If the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year,” Powell said in the comments. “But the economic outlook is uncertain, and ongoing progress toward our 2 percent inflation objective is not assured.”

He noted again that lowering rates too quickly risks losing the battle against inflation and likely having to raise rates further, while waiting too long poses danger to economic growth.

Markets had been widely expecting the Fed to ease up aggressively following 11 interest rate hikes totaling 5.25 percentage points that spanned March 2022 to July 2023.

In recent weeks, though, those expectations have changed following multiple cautionary statements from Fed officials. The January meeting helped cement the Fed’s cautious approach, with the statement explicitly saying rate cuts aren’t coming yet despite the market’s outlook.

As things stand, futures market pricing points to the first cut coming in June, part of four reductions this year totaling a full percentage point. That’s slightly more aggressive than the Fed’s outlook in December for three cuts.

Inflation easing

Despite the resistance to move forward on cuts, Powell noted the movement the Fed has made toward its goal of 2% inflation without tipping over the labor market and broader economy.

“The economy has made considerable progress toward these objectives over the past year,” Powell said. He noted that inflation has “eased substantially” as “the risks to achieving our employment and inflation goals have been moving into better balance.”

Inflation as judged by the Fed’s preferred gauge is currently running at a 2.4% annual rate — 2.8% when stripping out food and energy in the core reading that the Fed prefers to focus on. The numbers reflect “a notable slowing from 2022 that was widespread across both goods and services prices.”

“Longer-term inflation expectations appear to have remained well anchored, as reflected by a broad range of surveys of households, businesses, and forecasters, as well as measures from financial markets,” he added.

Powell is likely to face a variety of questions during his two-day visit to Capitol Hill, which started with an appearance Wednesday before the House Financial Services Committee and concludes Thursday before the Senate Banking Committee.

Questioning largely centered around Powell’s views on inflation and rates.

Republicans on the committee also grilled Powell on the so-called Basel III Endgame revisions to bank capital requirements. Powell said he is part of a group on the Board of Governors that has “real concerns, very specific concerns” about the proposals and said the withdrawal of the plan “is a live option.” Some of the earlier market gains Wednesday faded following reports that New York Community Bank is looking to raise equity capital, raising fresh concerns about the state of midsize U.S. banks.

Though the Fed tries to stay out of politics, the presidential election year poses particular challenges.

Former President Donald Trump, the likely Republican nominee, was a fierce critic of Powell and his colleagues while in office. Some congressional Democrats, led by Sen. Elizabeth Warren of Massachusetts, have called on the Fed to reduce rates as pressure builds on lower-income families to make ends meet.

Rep. Ayanna Pressley, D-Mass., joined the Democrats in calling for lower rates. During his term, Democrats frequently criticized Trump for trying to cajole the Fed into cutting.

“Housing inflation and housing affordability [is] the No. 1 issue I’m hearing about from my constituents,” Pressley said. “Families in my district and throughout this country need relief now. I truly hope the Fed will listen to them and cut interest rates.”

Correction: Ayanna Pressley is a Democratic representative from Massachusetts. An earlier version misidentified the state.

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Fed officials expressed caution about lowering rates too quickly at last meeting, minutes show

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WASHINGTON – Federal Reserve officials indicated at their last meeting that they were in no hurry to cut interest rates and expressed both optimism and caution on inflation, according to minutes from the session released Wednesday.

The discussion came as policymakers not only decided to leave their key overnight borrowing rate unchanged but also altered the post-meeting statement to indicate that no cuts would be coming until the rate-setting Federal Open Market Committee held “greater confidence” that inflation was receding.

“Most participants noted the risks of moving too quickly to ease the stance of policy and emphasized the importance of carefully assessing incoming data in judging whether inflation is moving down sustainably to 2 percent,” the minutes stated.

The meeting summary did indicate a general sense of optimism that the Fed’s policy moves had succeeded in lowering the rate of inflation, which in mid-2022 hit its highest level in more than 40 years.

However, officials noted that they wanted to see more before starting to ease policy, while saying that rate hikes are likely over.

“In discussing the policy outlook, participants judged that the policy rate was likely at its peak for this tightening cycle,” the minutes stated. But, “Participants generally noted that they did not expect it would be appropriate to reduce the target range for the federal funds rate until they had gained greater confidence that inflation was moving sustainably toward 2 percent.”

Before the meeting, a string of reports showed that inflation, while still elevated, was moving back toward the Fed’s 2% target. While the minutes assessed the “solid progress” being made, the committee viewed some of that progress as “idiosyncratic” and possibly due to factors that won’t last.

Consequently, members said they will “carefully assess” incoming data to judge where inflation is heading over the longer term. Officials noted both upside and downside risks and worried about lowering rates too quickly.

Questions over how quickly to move

“Participants highlighted the uncertainty associated with how long a restrictive monetary policy stance would need to be maintained,” the summary said.

Officials “remained concerned that elevated inflation continued to harm households, especially those with limited means to absorb higher prices,” the minutes said. “While the inflation data had indicated significant disinflation in the second half of last year, participants observed that they would be carefully assessing incoming data in judging whether inflation was moving down sustainably toward 2 percent.”

The minutes reflected an internal debate over how quickly the Fed will want to move considering the uncertainty about the outlook.

Since the Jan. 30-31 meeting, the cautionary approach has borne out as separate readings on consumer and producer prices showed inflation running hotter than expected and still well ahead of the Fed’s 2% 12-month target.

Multiple officials in recent weeks have indicated a patient approach toward loosening monetary policy. A stable economy, which grew at a 2.5% annualized pace in 2023, has encouraged FOMC members that the succession of 11 interest rate hikes implemented in 2022 and 2023 have not substantially hampered growth.

To the contrary, the U.S. labor market has continued to expand at a brisk pace, adding 353,000 nonfarm payroll positions in January. First-quarter economic data thus far is pointing to GDP growth of 2.9%, according to the Atlanta Fed.

Along with the discussion on rates, members also brought up the bond holdings on the Fed’s balance sheet. Since June 2022, the central bank has allowed more than $1.3 trillion in Treasurys and mortgage-backed securities to roll off rather than reinvesting proceeds as usual.

‘Ample level of reserves’

The minutes indicated that a more in-depth discussion will take place at the March meeting. Policymakers also indicated at the January meeting that they are likely to take a go-slow approach on a process nicknamed “quantitative tightening.” The pertinent question is how high reserve holdings will need to be to satisfy banks’ needs. The Fed characterizes the current level as “ample.”

“Some participants remarked that, given the uncertainty surrounding estimates of the ample level of reserves, slowing the pace of runoff could help smooth the transition to that level of reserves or could allow the Committee to continue balance sheet runoff for longer,” the minutes said. “In addition, a few participants noted that the process of balance sheet runoff could continue for some time even after the Committee begins to reduce the target range for the federal funds rate.”

Fed officials consider current policy to be restrictive, so the big question going forward will be how much it will need to be relaxed both to support growth and control inflation.

There is some concern that growth continues to be too fast.

The consumer price index rose 3.1% on a 12-month basis in January – 3.9% when excluding food and energy, the latter of which posted a big decline during the month. So-called sticky CPI, which weighs toward housing and other prices that don’t fluctuate as much, rose 4.6%, according to the Atlanta Fed. Producer prices increased 0.3% on a monthly basis, well above Wall Street expectations.

In an interview on CBS’ “60 Minutes” that aired just a few days after the FOMC meeting, Chair Jerome Powell said, “With the economy strong like that, we feel like we can approach the question of when to begin to reduce interest rates carefully.” He added that he is looking for “more evidence that inflation is moving sustainably down to 2%.”

Markets have since had to recalibrate their expectations for rate cuts.

Where traders in the fed funds futures market had been pricing in a near lock for a March cut, that has been pushed out to June. The expected level of cuts for the full year had been reduced to four from six. FOMC officials in December projected three.

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As inflation falls, corporate America won’t rush to pay the price

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U.S. President Joe Biden delivers remarks during an event to celebrate the anniversary of his signing of the 2022 Inflation Reduction Act legislation, in the East Room of the White House in Washington, U.S., August 16, 2023. 

Kevin Lamarque | Reuters

In recent weeks, President Joe Biden has been doing everything he can to point the finger at big corporations for high prices.

“Too many things are unaffordable,” the president said.

“Stop the price gouging,” Biden said on another recent occasion.

The blame game may be good retail politics, and the president has announced some real actions to alleviate consumer financial stress, forgiving as much student debt on the margins as he can under the law, unveiling various plans to eliminate “junk fees,” and using new powers under the Inflation Reduction Act to bring down key drug prices.

Some recent research supports the case that corporations have taken more advantage of the current inflationary era than they really need to do. But amid the political pressure, don’t expect corporate America to be swayed.

As the Federal Reserve signals for the first time that it’s getting comfortable with the decline in inflation, and even short of declaring “mission accomplished” seemed to say this week it doesn’t wholly disagree with the market view that rates cuts are the next phase in its monetary policy, the one major force in the economy not talking about cuts in a major way is corporations.

That’s been on the mind of Fed presidents as the central bank contemplates a big shift. Richmond Fed President Tom Barkin, a former corporate sector CFO, recently told CNBC that one area he monitors and speaks to companies about is price setting. Companies won’t be giving up their power to raise prices “until they have to,” Barkin, who will be a voting member of the FOMC next year, said.

It’s been a hard-won advantage. Over the past two decades, price setters “have been beaten up,” Barkin said, by the combination of ecommerce, globalization, access to new supply and the power of big box retailers. “If you go back to 2018-2019, you had people who really weren’t into raising prices [as they] didn’t think they had the power to do it. I’m out there talking to price setters now and there are some who have taken a step back and said, ‘Okay, we’re on the backside of this,’ but I still talk [to others] who are looking to get more price.”

During an interview later in November with Barkin at CNBC’s CFO Council Summit in Washington, D.C., the subject came up again, and an informal poll of CFO Council members in the room on the subject of pricing plans for 2024 was taken. A majority said their companies would be raising prices next year; a minority said they would keep pricing the same; none said they would be lowering prices. 

“I’m looking for the point where they’re no longer taking outsized price increases because they’re worried the volume and the market won’t sustain it,” Barkin said.

That is happening in certain goods markets where the Covid outsized demand has waned, and as the pressures in the real estate market with high mortgage rates have cut down on purchases for the home. It’s also a function of a massive freight market recession, which has sharply lowered transportation costs for shippers after a period of huge contract rate increases during the pandemic boom. A recent decline in energy prices has also lessened input cost pressures.

Costco CFO Richard Galanti said after its earnings this week that inflation for the quarter just ended was in the 0% to 1% range. But the big moves were in the “big and bulky items,” like furniture sets due to lower freight costs year-over-year, as well as on “things like domestics,” he said. And what he called the “deflationary items” were steeply down in price, as much as 20% to 30%.

Toys are another example.

No one wants to be the first to cut prices

Overall, though, the economy is not headed for deflation, and the Fed’s stance this week may have given companies more room to keep prices where they want if real wage growth proves sustainable. “Inflation is falling faster than wages,” said KMPG chief economist Diane Swonk. “That does not equate to deflation. The goal is to keep that trend going, so that consumers regain the purchasing power lost to inflation.”

But with any easing of rates, the central bank is “willing to throw the dice, and enable the economy to grow more rapidly rather than risk recession,” Swonk said. “That is a major shift from where we were a year ago. They knew that the decision to call an end to rate hikes would trigger financial markets to ease. That was like a stealth cut in rates. It will stimulate the economy. Improvements in inflation are expected to continue, but the pace at which price increases decelerate could slow.”

The recent tailwinds from a softer freight market may be near their end, too. A logistics CFO speaking on a CNBC CFO Council member call on Tuesday about the market outlook said that after one of the longest stretches in recent history for a freight recession, the trough may have been reached. “Truck rates may start bouncing off of a bottom here,” said the logistics CFO on the call, where chief financial officers are granted anonymity to speak freely.

While the Fed may get its wish of a “soft landing” for the economy, that doesn’t mean prices will land as softly for consumers, according to Marco Bertini, a professor of marketing at business school Esade who studies pricing strategy and pricing psychology. “Companies will do what they want and will never react at the speed you want them to, especially after they have been increasing prices,” Bertini said. “Why would I be the first to cut my margins when we just went through a period where we had the world’s best excuse [inflation] to recover margins?” he said.

At some point, companies will need to reassess pricing strategy, especially with margins more than recovered for many, and this period of rapid inflation in the U.S. doesn’t have a precedent for companies to use as a barometer of how to shift. “It’s uncharted territory for the U.S. market,” Bertini said.

That’s part of the reason why not one CFO raised their hand at the CNBC CFO Council Summit when asked if any were considering a price decrease for 2024.

“Imagine I am the first to say I am holding on prices, and make that known to customers? That’s how a price war starts and the competitive advantage from being the ‘good guy’ lasts two seconds,” Bertini said. “No one wants a race to the bottom. The gains over the past few years evaporate in a few months.”

Deflation versus slowing of price increases

There are some signs that the pricing conversation is starting to become more prevalent inside companies beyond the goods areas where demand has been hit hard. But recent declines in pricing don’t indicate that companies will continue in that direction across a broader array of products and services.

“The Fed doesn’t want to see deflation,” said one retail sector CFO on the recent CNBC CFO Council call. “They just want to see inflation cool. And they want to see us get to the point where we can’t raise prices anymore.”

While the CFO said there has been a “settling in the market in the last couple of months, I wouldn’t call it deflation.”

But he pointed to transportation costs as a deflationary force that is having an influence on importers, “a one-time kind of release of supply and demand imbalances … but it’s a price correction to me that is different than deflation. … I think we’ve kind of been through an interesting phase of price correction. But I’d say things are pretty stable from our perspective.”

Consumers have been 'as resilient as they could be,' says former Walmart U.S. CEO Bill Simon

In food distribution, costs for key commodities continue to experience deflation on a sequential basis. But consumers going out to eat won’t see that in the prices they pay.

“We’re in a period where restauranteurs have taken many prices up,” said another retail CFO on the call. “They’re seeing that deflation in their underlying ingredients, so they’re actually going to start seeing a little bit better performance in terms of their bottom line. Now that they’ve taken the prices up, we just don’t think they’re gonna take it down very quickly.”

The science of pricing, according to Bertini, dictates that as long as a company can point to an externality — in this case, higher input costs — the buyer ultimately accepts the situation, and price stickiness is the result.

But the current environment is edging into more of an “unstable equilibrium.”

“When inflation is in the public domain, it’s perfect to collaborate in a perfectly legal way to increase prices. Now the shocks are gone and costs slowly coming down, and the appetite to be the one to decrease prices and get market share gain is increasingly getting bigger,” he said. “But being the first will take some time, because they’re still enjoying it. … What it will take in most markets is a competitor who sees a clear path to getting lots of market share.”

When the party will end for corporations

This difficult balance is also coming during a period of time when the consumer has defied expectations of a slowdown in spending, making it harder for companies to pinpoint just how big the market opportunity really is. Retail sales, as an example, just came in much stronger than expected.

“We’re still trying to understand how strong November retail sales should have been relative to normal, and relative to what’s happened the last three years. It makes it hard,” the logistics CFO said on the recent CNBC CFO Council call.

The view from Costco CFO Galanti after its earnings this week is instructive. Speaking about food, he said it’s been a different story than with goods: “There hasn’t been significant price cuts passed on to the consumer yet.”

“There are a few things that are up and a few things are down, but no giant trend either way. Look, as you’ve known us for a long time, we want to be the first to lower prices. We’re out there pressing our vendors as we see different commodity components come down and certainly on the non-food side as we saw shipping costs come down, things like that. And so, probably a little more than less, but we’ll have to wait and see.”

If the period of price increases is to end, expect there to be a lag between that and other forces in the economy, such as the Fed, said Bertini. “Who wants to end the party early? They will want to see some really strong evidence that the party has ended.”

Another analogy from a CFO on the recent CNBC Council call may have put it best:

“We’re all a bunch of cars on a highway. You’ve got the customer, a retailer, you’ve got the manufacturer. Maybe you’ve got capital providers. And who hits the brakes first? Who wants to hit the brakes before the person in front of them hits the brakes?” 

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Fed holds rates steady, upgrades assessment of economic growth

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The Federal Reserve on Wednesday again held benchmark interest rates steady amid a backdrop of a growing economy and labor market and inflation that is still well above the central bank’s target.

In a widely expected move, the Fed’s rate-setting group unanimously agreed to hold the key federal funds rate in a target range between 5.25%-5.5%, where it has been since July. This was the second consecutive meeting that the Federal Open Market Committee chose to hold, following a string of 11 rate hikes, including four in 2023.

The decision included an upgrade to the committee’s general assessment of the economy. Stocks rallied on the news, with the Dow Jones Industrial Average gaining 212 points on the session.

“The process of getting inflation sustainably down to 2% has a long way to go,” Fed Chair Jerome Powell said in remarks at a news conference. He stressed that the central bank hasn’t made any decisions yet for its December meeting, saying that “The committee will always do what it thinks is appropriate at the time.”

Powell added that the FOMC is not considering or even discussing rate reductions at this time.

He also said the risks around the Fed doing too much or too little to fight inflation have become more balanced.

“This signals that while there is a potential risk for the Fed to do more, the bar has become higher for rate hikes, and we are clearly seeing this play out with two consecutive meetings of no policy action from the Fed,” said Charlie Ripley, senior investment strategist at Allianz Investment Management.

Economy has ‘moderated’

The post-meeting statement had indicated that “economic activity expanded at a strong pace in the third quarter,” compared with the September statement that said the economy had expanded at a “solid pace.” The statement also noted that employment gains “have moderated since earlier in the year but remain strong.”

Gross domestic product expanded at a 4.9% annualized rate in the third quarter, stronger than even elevated expectations. Nonfarm payrolls growth totaled 336,000 in September, well ahead of the Wall Street outlook.

There were few other changes to the statement, other than a notation that both financial and credit conditions had tightened. The addition of “financial” to the phrase followed a surge in Treasury yields that has caused concern on Wall Street. The statement continued to note that the committee is still “determining the extent of additional policy firming” that it may need to achieve its goals. “The Committee will continue to assess additional information and its implications for monetary policy,” the statement said.

Wednesday’s decision to stay put comes with inflation slowing from its rapid pace of 2022 and a labor market that has been surprisingly resilient despite all the interest rate hikes. The increases have been targeted at easing economic growth and bringing a supply and demand mismatch in the labor market back into balance. There were 1.5 available jobs for every available worker in September, according to Labor Department data released earlier Wednesday.

Core inflation is currently running at 3.7% on an annual basis, according to the latest personal consumption expenditures price index reading, which the Fed favors as an indicator for prices.

While that has decreased steadily this year, it is well above the Fed’s 2% annual target.

The post-meeting statement indicated that the Fed sees the economy holding strong despite the rate hikes, a position in itself that could prompt policymakers into a prolonged tightening stance.

In recent days, the “higher-for-longer” mantra has become a central theme for where the Fed is headed. While multiple officials have said they think rates can stay where they are as the Fed assesses the impact of the previous increases, virtually none have said they are considering cuts anytime soon. Market pricing indicates the first cut could come around June 2024, according to CME Group data.

Surging bond yields

The restrictive stance has been a factor in the surging bond yields. Treasury yields have risen to levels not seen since 2007, the earliest days of the financial crisis, as markets parse out what is ahead. Yields and prices move in opposite direction, so a rise in the former reflects waning investor appetite for Treasurys, generally considered the largest and most liquid market in the world.

The surge in yields is seen as a byproduct of multiple factors, including stronger-than-expected economic growth, stubbornly high inflation, a hawkish Fed and an elevated “term premium” for bond investors demanding higher yields in return for the risk of holding longer-duration fixed income.

There also are worries over Treasury issuance as the government looks to finance its massive debt load. The department this week said it will be auctioning off $776 billion of debt in the fourth quarter, starting with $112 billion across three auctions next week.

During a recent appearance in New York, Powell said he thinks the economy may have to slow further to bring down inflation. Most forecasters expect economic growth to tail off ahead.

A Treasury Department forecast released earlier this week indicated that the pace of growth likely will tumble to 0.7% in the fourth quarter and just 1% for the full year in 2024. Projections the Fed released in September put expected GDP growth at 1.5% in 2024.

In the wake of the Fed’s comments, the Atlanta Fed’s GDPNow growth tracker slashed expectations for fourth-quarter GDP almost in half to 1.2% from 2.3%. The gauge takes in data on a real-time basis and adjusts its estimates with the latest information.

Whitney Watson, co-CIO of fixed income and liquidity solutions at Goldman Sachs Asset Management, said it’s likely the Fed will keep its policy unchanged into next year.

“There are risks in both directions,” Watson said. “The rise in inflation expectations, owing to higher gas prices, combined with strong economic activity, preserves the prospect of another rate hike. Conversely, a more pronounced economic slowdown caused by the growing impact of higher interest rates might accelerate the timeline for transitioning to rate cuts.”

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Getting to 2% inflation won’t be easy. This is what will need to happen, and it might not be pretty

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A construction in a multifamily and single family residential housing complex is shown in the Rancho Penasquitos neighborhood, in San Diego, California, September 19, 2023.

Mike Blake | Reuters

In theory, getting inflation closer to the Federal Reserve’s 2% target doesn’t sound terribly difficult.

The main culprits are related to services and shelter costs, with many of the other components showing noticeable signs of easing. So targeting just two areas of the economy doesn’t seem like a gargantuan task compared to, say, the summer of 2022 when basically everything was going up.

In practice, though, it could be harder than it looks.

Prices in those two pivotal components have proven to be stickier than food and gas or even used and new cars, all of which tend to be cyclical as they rise and fall with the ebbs and flows of the broader economy.

Instead, getting better control of rents, medical care services and the like could take … well, you might not want to know.

“You need a recession,” said Steven Blitz, chief U.S. economist at GlobalData TS Lombard. “You’re not going to magically get down to 2%.”

Annual inflation as measured by the consumer price index fell to 3.7% in September, or 4.1% if you kick out volatile food and energy costs, the latter of which has been rising steadily of late. While both numbers are still well ahead of the Fed’s goal, they represent progress from the days when headline inflation was running north of 9%.

The CPI components, though, told of uneven progress, helped along by an easing in items such as used-vehicle prices and medical care services but hampered by sharp increases in shelter (7.2%) and services (5.7% excluding energy services).

Drilling down further, rent of shelter also rose 7.2%, rent of primary residence was up 7.4%, and owners’ equivalent rent, pivotal figures in the CPI computation that indicates what homeowners think they could get for their properties, increased 7.1%, including a 0.6% gain in September.

Without progress on those fronts, there’s little chance of the Fed achieving its goal anytime soon.

Uncertainty ahead

“The forces that are driving the disinflation among the various bits and micro pieces of the index eventually give way to the broader macro force, which is rising, which is above-trend growth and low unemployment,” Blitz said. “Eventually that will prevail until a recession comes in, and that’s it, there’s nothing really much more to say than that.”

On the bright side, Blitz is among those in the consensus view that see any recession being fairly shallow and short. And on the even brighter side, many Wall Street economists, Goldman Sachs among them, are coming around to the view that the much-anticipated recession may not even happen.

In the interim, though, uncertainty reigns.

“Sticky-price” inflation, a measure of things such as rents, various services and insurance costs, ran at a 5.1% pace in September, down a full percentage point from May, according to the Atlanta Fed. Flexible CPI, including food, energy, vehicle costs and apparel, ran at just a 1% rate. Both represent progress, but still not a goal achieved.

Markets are puzzling over what the central bank’s next step will be: Do policymakers slap on another rate hike for good measure before year-end, or do they simply stick to the relatively new higher-for-longer script as they watch the inflation dynamics unfold?

“Inflation that is stuck at 3.7%, coupled with the strong September employment report, could be enough to prompt the Fed to indeed go for one more rate hike this year,” said Lisa Sturtevant, chief economist for Bright MLS, a Maryland-based real estate services firm. “Housing is the key driver of the elevated inflation numbers.”

Higher interest rates’ biggest impact has been on the housing market in terms of sales and financing costs. Yet prices are still elevated, with concern that the high rates will deter construction of new apartments and keep supply constrained.

Those factors “will only lead to higher rental prices and worsening affordability conditions in the long run,” wrote Christopher Bruen, senior director of research at the National Multifamily Housing Council. “Rising rates threaten the strength of the broader job market and economy, which has not yet fully digested the rate hikes already enacted.”

Longer-run concerns

The notion that rate increases totaling 5.25 percentage points have yet to wind their way through the economy is one factor that could keep the Fed on hold.

That, however, goes back to the idea that the economy still needs to cool before the central bank can complete the final mile of its race to bring down inflation to the 2% target.

One positive in the Fed’s favor is that pandemic-related factors largely have washed out of the economy. But other factors linger.

“Pandemic-era effects have a natural gravitational pull and we’ve seen that take place over the course of the year,” said Marta Norton, chief investment officer for the Americas at Morningstar Wealth. “However, bringing inflation the remainder of the distance to the 2% target requires economic cooling, no easy feat, given fiscal easing, the strength of the consumer and the general financial health in the corporate sector.”

Fed officials expect the economy to slow this year, though they have backed off an earlier call for a mild recession.

Policymakers have been banking on the notion that when existing rental leases expire, they will be renegotiated at lower prices, bringing down shelter inflation. However, the rising shelter and owners’ equivalent rent numbers are running counter to that thinking even though so-called asking rent inflation is easing, said Stephen Juneau, U.S. economist at Bank of America.

“Therefore, we must wait for more data to see if this is just a blip or if there is something more fundamental driving the increase such as higher rent increases in larger cities offsetting softer increases in smaller cities,” Juneau said in a note to clients Thursday. He added that the CPI report “is a reminder that we do not have good historic examples to lean on” for long-term patterns in rent inflation.

Core service numbers show inflation is still relatively elevated, says Nationwide's Kathy Bostjancic

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Fed Chair Powell calls inflation ‘too high’ and warns that ‘we are prepared to raise rates further’

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Federal Reserve Chair Jerome Powell on Friday called for more vigilance in the fight against inflation, warning that additional interest rate increases could be yet to come.

While acknowledging that progress has been made and saying the Fed will be careful in where it goes from here, the central bank leader said inflation is still above where policymakers feel comfortable. He noted that the Fed will remain flexible as it contemplates further moves, but gave little indication that it’s ready to start easing anytime soon.

“Although inflation has moved down from its peak — a welcome development — it remains too high,” Powell said in prepared remarks for his keynote address at the Kansas City Fed’s annual retreat in Jackson Hole, Wyoming. “We are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.”

The speech resembled remarks Powell made last year at Jackson Hole, during which he warned that “some pain” was likely as the Fed continues its efforts to pull runaway inflation back down to its 2% goal.

But inflation was running well ahead of its current pace back then. Regardless, Powell indicated it’s too soon to declare victory, even with data this summer running largely in the Fed’s favor. June and July both saw easing in the pace of price increases, with core inflation up 0.2% for each month, according to the Bureau of Labor Statistics.

“The lower monthly readings for core inflation in June and July were welcome, but two months of good data are only the beginning of what it will take to build confidence that inflation is moving down sustainably toward our goal,” he said.

Powell acknowledged that risks are two-sided, with dangers of doing both too much and too little.

Powell's concerns about growth and the labor market being too strong are new, says Point72's Maki

“Doing too little could allow above-target inflation to become entrenched and ultimately require monetary policy to wring more persistent inflation from the economy at a high cost to employment,” he said. “Doing too much could also do unnecessary harm to the economy.”

“As is often the case, we are navigating by the stars under cloudy skies,” he added.

Markets were volatile after the speech, but stocks powered higher later in the day and Treasury yields were mostly up. In 2022, stocks plunged following Powell’s Jackson Hole speech.

“Was he hawkish? Yes. But given the jump in yields lately, he wasn’t as hawkish as some had feared,” said Ryan Detrick, chief market strategist at the Carson Group. “Remember, last year he took out the bazooka and was way more hawkish than anyone expected, which saw heavy selling into October. This time he hit it more down the middle, with no major changes in future hikes a welcome sign.”

A need to ‘proceed carefully’

Powell’s remarks follow a series of 11 interest rate hikes that have pushed the Fed’s key interest rate to a target range of 5.25%-5.5%, the highest level in more than 22 years. In addition, the Fed has reduced its balance sheet to its lowest level in more than two years, a process which was seen about $960 billion worth of bonds roll off since June 2022.

Markets of late have been pricing in little chance of another hike at the September meeting of the Federal Open Market Committee, but are pointing to about a 50-50 chance of a final increase at the November session. Projections released in June showed that almost all FOMC officials saw another hike likely this year.

Powell provided no clear indication of which way he sees the decision going.

“Given how far we have come, at upcoming meetings we are in a position to proceed carefully as we assess the incoming data and the evolving outlook and risks,” he said.

However, he gave no sign that he’s even considering a rate cut.

“At upcoming meetings, we will assess our progress based on the totality of the data and the evolving outlook and risks,” Powell said. “Based on this assessment, we will proceed carefully as we decide whether to tighten further or, instead, to hold the policy rate constant and await further data.”

The chair added that economic growth may have to slow before the Fed can change course.

Gross domestic product has increased steadily since the rate hikes began, and the third quarter of 2023 is tracking at a 5.9% growth pace, according to the Atlanta Fed. Employment also has stayed strong, with the jobless rate hovering around lows last seen in the late 1960s.

“The basic thought that they’re close to done, they think they probably have a little bit more to do … that is the story they’ve been telling for a little while. And that was the heart of what he said today,” said Bill English, a former Fed official and now a Yale finance professor.

“I don’t think this is about sending a signal. I think this is really where they think they are,” he added. “The economy has slowed some but not enough yet to make them confident inflation is going to come down.”

Indeed, Powell noted the risk of strong economic growth in the face of widespread recession expectations and how that could make the Fed hold rates higher for longer.

“It was a balanced but not trend-changing speech, even if the Fed kept the ‘mission accomplished’ banner in the closet,” said Jack McIntyre, portfolio manager at Brandywine Global. “It leaves the Fed with needed optionality to either tighten more or keep rates on hold.”

Getting into details

While last year’s speech was unusually brief, this time around Powell provided a little more detail into the factors that will go into policymaking.

Specifically, he broke inflation into three key metrics and said the Fed is most focused on core inflation, which excludes volatile food and energy prices. He also reiterated that the Fed most closely follows the personal consumption expenditures price index, a Commerce Department measure, rather than the Labor Department’s consumer price index.

The three “broad components” of which he spoke entail goods, housing services such as rental costs and nonhousing services. He noted progress on all three, but said nonhousing is the most difficult to gauge as it is the least sensitive to interest rate adjustments. That category includes such things as health care, food services and transportation.

“Twelve-month inflation in this sector has moved sideways since liftoff. Inflation measured over the past three and six months has declined, however, which is encouraging,” Powell said. “Given the size of this sector, some further progress here will be essential to restoring price stability.”

No change to inflation goal

In addition to the broader policy outlook, Powell honed in some areas that are key both to market and political considerations.

Some legislators, particularly on the Democratic side, have suggested the Fed raise its 2% inflation target, a move that would give it more policy flexibility and might deter further rate hikes. But Powell rejected that idea, as he has done in the past.

“Two percent is and will remain our inflation target,” he said.

That portion of the speech brought some criticism from Harvard economist Jason Furman.

“Jay Powell said all the right things about near-term monetary policy, continuing to hope for the best while planning for the worst. He was appropriately cautious on inflation progress & asymmetric about the policy stance,” Furman, who was chair of the Council of Economic Advisers under former President Barack Obama, posted on X, the social media site formerly known as Twitter. “But wish he had not ruled out shifting the target.”

On another issue, Powell chose largely to stay away from the debate over what is the longer-run, or natural, rate of interest that is neither restrictive nor stimulative – the “r-star” rate of which he spoke at Jackson Hole in 2018.

“We see the current stance of policy as restrictive, putting downward pressure on economic activity, hiring, and inflation,” he said. “But we cannot identify with certainty the neutral rate of interest, and thus there is always uncertainty about the precise level of monetary policy restraint.”

Powell also noted that the previous tightening moves likely haven’t made their way through the system yet, providing further caution for the future of policy.

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Mortgage points may help homebuyers lower monthly costs amid high interest rates. How to know if this strategy is right for you

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As interest rates have climbed, homebuyers have been confronted with higher borrowing costs.

That has led more home purchasers to opt for one strategy, purchasing mortgage points, as a way to defray higher monthly payments.

Mortgage points let buyers pay an upfront fee to lower the interest rate on their loans. In some cases, sellers will help to buy down rates to help ease transaction costs.

Almost 45% of conventional primary home borrowers bought mortgage points in 2022 to reduce their monthly mortgage payments, a trend that has continued into this year, according to recent research from Zillow.

That is up from 29.6% in 2021, when interest rates were lower.

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The 30-year fixed-rate mortgage currently averages 6.7% according to Freddie Mac, up from 5.8% a year ago. The 15-year fixed-rate mortgage now averages about 6%, up from 4.8% a year ago.

This week, the Federal Reserve decided to pause the interest rate hikes it has put in place to combat high inflation.

As rates stay higher, those who are in the market for a home lose purchasing power. Some experts have urged buyers to consider purchasing mortgage points to lower their monthly payments.

Stephanie Grubbs, a licensed real estate agent at the Zweben team at Douglas Elliman Real Estate in New York, recently did exactly that when one of her clients lowered their asking price.

“This fabulous apartment just had a price reduction, which means you can use those savings to buy down your rate,” Grubbs wrote in the updated ad.

Grubbs, a former financial advisor, said her firm started bringing up the strategy more when the Fed started hiking interest rates.

“In an effort to try to be creative, we talk to sellers about offering to buy down a rate,” Grubbs said.

Other experts say buyers purchasing mortgage points can be a great strategy for the right situation.

That goes particularly if a buyer can afford the extra upfront costs.

Being able to lower that monthly payment can really help give some more wiggle room in people’s budgets and help them reach affordability.

Nicole Bachaud

senior economist at Zillow

Mortgage points refer to the percentage amount of the loan. Typically, one point is worth 1% of the loan value, according to Nicole Bachaud, senior economist at Zillow.

If the loan value is $300,000, one point would typically cost $3,000 and lower the interest rate 0.25 percentage points, she said.

“Being able to lower that monthly payment can really help give some more wiggle room in people’s budgets and help them reach affordability,” Bachaud said.

In addition to higher upfront costs, home buyers should also weigh other factors before buying mortgage points.

Set a timeline for living in your new home

“For most instances, it is definitely a considerable cost savings to be able to buy down on points,” said Kamila Elliott, a certified financial planner and co-founder and CEO of Collective Wealth Partners, a boutique advisory firm in Atlanta. Elliott is also a member of the CNBC Financial Advisor Council.

However, if you buy points and then refinance, that will not allow enough time for your upfront payment to appreciate, Elliott said.

Another important consideration is your timeline for how long you plan to live in the home.

With rates and home prices high, that means closing costs are also elevated, Elliott said.

Consequently, if you move before three to five years, you may take a bigger financial hit, she said.

“There could be a huge loss if you can’t stay in that property long enough to have those expenses amortized out over the time that you’re there,” Elliott said.

Consider other alternatives

If you have extra money when buying a home, you may instead choose to increase the size of your down payment.

This can be advantageous because it creates more equity in the home, Bachaud noted. It may also lower your monthly payments.

If that extra money is enough to bring your down payment to 20% of the home purchase price, that would eliminate the need for private mortgage insurance, which adds to monthly costs for mortgage borrowers who put down less than those sums.

However, you may see more of an effect on your monthly expenses by buying points rather than increasing your down payment, Elliott said.

It costs less for a seller to buy down somebody’s mortgage than it does for them to take a price reduction.

Stephanie Grubbs

licensed real estate agent at Douglas Elliman Real Estate

A point may cost $3,000 to $4,000, for example. But putting those sums toward a down payment likely will not make much of a difference on your monthly costs, Elliott said.

If you want to make sure your mortgage payment doesn’t exceed one-third of your take home income, then paying down on points could be the better option, she said.

In some situations, a seller may offer to buy down the rate, a concession to help offset costs for buyers. Grubbs said she has discussed employing this strategy with clients in her real estate practice.

“It costs less for a seller to buy down somebody’s mortgage than it does for them to take a price reduction,” Grubbs said.

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Homebuyers may want to consider pursuing a 2-1 buydown, a mortgage that provides a low interest rate for the first year, a slightly higher rate in the second year and a full rate for the following years.

A 2-1 buydown may also sometimes be seller financed, according to Bachaud.

Talking to a loan officer can help you decide the best decision for your situation, Bachaud said.

Factor in the unknowns

How well any homebuying strategy fares in the long run depends on one big unknown: how the Federal Reserve will handle interest rates going forward.

The latest projections from the central bank call for two more rate hikes this year.

While today’s rates feel high, Elliott said she often reminds people that homebuyers in the 1980s would have loved to have had access to 6% mortgage rates.

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Buyers need a six-figure income to afford a ‘typical’ home, report finds. Here’s how to reduce the cost

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It’s no secret that it’s a tough market for prospective home buyers.

In October, U.S. buyers needed to earn $107,281 to afford the median monthly mortgage payment of $2,682 for a “typical home,” Redfin reported this week. 

That’s 45.6% higher than the $73,668 yearly income needed to cover the median mortgage payment 12 months ago, the report finds.

The primary reason is rising mortgage interest rates, said Melissa Cohn, regional vice president at William Raveis Mortgage. “The bottom line is mortgage rates have more than doubled since the beginning of the year,” she said.

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Despite the sharp drop reported this week, the average interest rate for a 30-year fixed-rate mortgage of $647,200 or less was hovering below 7%, compared to under 3.50% at the beginning of January.

And while home values have softened in some markets, the average sales price is up from one year ago.

“Home prices have gone up substantially, mortgage rates have more than doubled and that’s just crushing affordability,” said Keith Gumbinger, vice president of mortgage website HSH.

Meanwhile, a higher cost of living is still cutting into Americans’ budgets, with annual inflation at 7.7% in October.

How to make your mortgage more affordable 

While the current conditions may feel bleak for buyers, experts say there are a few ways to reduce your monthly mortgage payment.

For example, a higher down payment means a smaller mortgage and lower monthly payments, Gumbinger explained. “More down in this sort of environment can definitely play a role in getting your mortgage cost under control,” he said.

Another option is an adjustable-rate mortgage, or ARM, which offers a lower initial interest rate compared to a fixed-rate mortgage. The rate later adjusts at a predetermined intervals to the market rate at that time.

An ARM may also be worth considering, as long as you understand the risks, Cohn said.

If you’re planning to stay in the home for several years, there’s a risk you won’t be able to refinance to a fixed-rate mortgage before the ARM adjusts, she said. And in a rising rate environment, it’s likely to adjust higher.

Your eligibility for a future refinance can change if your income declines or your home value drops. “That’s a greater risk, especially for a first-time homebuyer,” Cohn said.

Of course, home values and demand vary by location, which affects affordability, Gumbinger said. “Being patient and being opportunistic is a good strategy for market conditions like this,” he said.



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Federal Reserve’s increasing interest rate hikes put Main Street economy ‘dangerously close’ to edge of lending cliff

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Federal Reserve Board Chairman Jerome Powell speaks during a news conference following a two-day meeting of the Federal Open Market Committee (FOMC) in Washington, July 27, 2022.

Elizabeth Frantz | Reuters

The Federal Reserve’s decision to raise interest rates by three-quarters of a percentage point, or 75 basis points, for the third-consecutive time at the Federal Open Market Committee meeting, is a step being taken to cool the economy and bring down inflation, but it is also putting small business owners across the country in a lending fix they have not experienced since the 1990s.

If the Federal Reserve’s FOMC next moves match the market’s expectation for two more interest rate hikes by the end of the year, small business loans will reach at least 9%, maybe higher, and that will bring business owners to a difficult set of decisions. Businesses are healthy today, especially those in the rebounding services sector, and credit performance remains good throughout the small business community, according to lenders, but the Fed’s more aggressive turn against inflation will lead more business owners to think twice about taking out new debt for expansion.

Partly, it is psychological: with many business owners never having operated in anything but a low interest rate environment, the sticker shock on debt stands out more even if their business cash flow remains healthy enough to cover the monthly repayment. But there will also be more businesses finding it harder to make cash flow match monthly repayment at a time of high inflation across all of their other business costs, including goods, labor, and transportation.

“Demand for lending hasn’t changed yet, but we’re getting dangerously close to where people will start to second guess,” said Chris Hurn, the founder and CEO of Fountainhead, which specializes in small business lending.

“We’re not there yet,” he said. “But we’re closer.”

Increasing interest cost

As traditional banks and credit unions tighten lending standards and businesses begin to breach debt covenants based on debt service coverage ratios — the amount of cash flow needed to cover debt — more business owners will turn to the SBA loan market in which firms like Hurn’s specialize.

“Every time we get into one of these cycles and the economy is slowing and rates are going up, one of the few places to get business credit is SBA lenders,” he said.

But even in the SBA market, business owners are beginning to pause as a result of the Fed’s rate actions, said Rohit Arora, co-founder and CEO of Biz2Credit, which also focuses on small business lending. “From a credit perspective, people are getting more cognizant about increasing interest cost, and that the Fed will keep interest rates at 4-4.50%,” Arora said.

Fed officials signaled the intention on Wednesday of continuing to hike until the funds level hits a “terminal rate,” or end point of 4.6% in 2023.

“Even a month ago, this was a ‘2022 phenomenon’ and now they will have to live with the pain for longer,” Arora said. “It’s a harder decision now because you don’t have the Fed ‘put’ behind you,” he added, referring to an environment in which you could bank on adjustable loan rates not going higher.

Fed expected to keep rates higher for longer

The big change since the summer, reflected in the stock market as well, is the acknowledgment that the Fed is not likely to quickly reverse its interest rate hikes, as inflation proves stickier than previously forecast, and key areas of the economy, like the labor market, don’t cool fast enough. As recently as the last FOMC meeting in July, many economists, traders and business owners expected the Fed to be cutting rates as soon as early 2023.

Now, according to CNBC’s surveying of economists and investment managers, the Fed is likely to reach peak rates above 4% and hold rates there throughout 2023. This outlook implies at least two more rate hikes in November and December, for a total of at least 75 basis points more, and including Wednesday’s hike, 150 basis points in all from September through the end of the year. And that is a big change for business owners.

The FOMC meeting decision reinforced this expectation of a more hawkish Fed, with the two-year treasury bond yield hitting its highest rate since 2007 and the central bank’s expectations for when it starts cutting rates again pushed out even further in time. In 2025, the fed funds rate median target is 2.9%, implying restrictive Fed policy into 2025.

How SBA loans work and why rate hikes are a big issue

SBA loans are floating rate loans, meaning they re-adjust based on changes in the prime rate, and that has not been an issue for business owners during the low interest rate environment, but it is suddenly becoming a prominent concern. With SBA loans based on the prime rate, currently at 5.50%, the interest rates are already between 7%-8%. With the prime rate poised to reach 6.25% after the Fed’s latest 75 basis point hike, SBA loans are heading to as high as the 9%-9.5% range.

“Most of the business owners today, because they have lived in such a low rate environment, while they have floating interest rate loans they didn’t even realize that on existing loans it could go up,” Arora said. “Everyone expected with gas prices coming down to what I would call ‘pre-high inflation levels’ that things looked a lot better. Now people are realizing that oil prices don’t solve the problem and that’s new for lots of business owners who thought inflation would taper off and the Fed not be so hawkish.”

He stressed, like Hurn, that demand for business loans is still healthy, and unlike deteriorating consumer credit, small business credit performance is still strong because many firms were underleveraged pre-Covid and then supported by the multiple government programs during the pandemic, including the PPP and SBA EIDL loans. “They are well capitalized and are seeing strong growth because the economy is still doing pretty well,” Arora said, and he added that the majority of small businesses are in the service economy, which is the strongest part of the economy right now.

But many business owners were waiting for the Fed to cut in early 2023 before making new loan decisions. Now, they’ve been caught flatfooted by adjustable loan rates that went up, and an interest rate environment poised to go higher still.

“Lots of business owners look at gas prices first and that was true for most of the year, and now it’s broken down. Wage inflation and rent inflation are running amok, so we’re not seeing inflation coming down anytime soon,” Arora said.

That’s leading to more interest in fixed-rate products.

Fixed versus adjustable rate debt

Demand for fixed-rate loans is going up because businesses can lock in rates, from a year to three years. “Though it’s pretty late to the game, they feel like maybe the next 14 to 15 months, before rates start coming down, they can at least lock in a rate,” Arora said. “The expectation is, in the short term, SBA loans will adjust up and non-SBA loans are shorter tenure,” he said.

SBA loans range from three years to as long as 10 years.

A fixed rate loan, even if it is a little higher than an SBA loan today, may be the better option given the change in interest rate outlook. But there’s considerable potential downside. Trying to time the Fed’s policy has proven difficult. The change from the summer to now is proof of that. So if there is a significant recession and the Fed starts cutting rates earlier than the current expectation, then the fixed-rate loan becomes more expensive and getting out of it, though an option, would entail prepayment penalties.

“That’s the one big risk you run if taking a fixed-rate loan in this environment,” Arora said.

The other tradeoff in choosing a fixed-rate loan: the shorter duration means a higher monthly repayment amount. The amount a business can afford to pay back every month depends on the amount of income coming in, and a fixed rate loan with a higher monthly repayment amount requires a business to have more income to devote to servicing the loan.

“After 2008, business owners never experienced a jumped in SBA loans and now they see monthly interest payments increasing, and are feeling the pinch and starting to plan for it … get adjusted to the new reality,” Arora said. “Demand is still healthy but they are worried about the increased interest cost while they are still battling inflation, even as lower oil prices have helped them.”

SBA loan guaranty waiver ending

Another cost that is suddenly influencing the SBA loan decision is the end of a waiver this month on SBA loan guaranty fees that are traditionally charged to borrowers so that in the event of a default, the SBA pays the portion of the loan that was guaranteed.

With that waiver ending in September, the cost of guaranteeing a loan can be significant. For example, a 3% SBA guaranty fee on a $500,000 loan would cost the business borrowing the money $15,000.

“It’s adding to the costs,” Arora said.

It’s still a mistake to wait too long to access credit

While oil prices are coming down, food and other inventory costs remain high, as do rent and labor costs, and that means the need for working capital isn’t changing. And business owners who have been through downturns before know that the time to access credit is before the economy and cash flow start to deteriorate. At some point, in the most severe downturns, “you won’t get money at any cost,” Arora said.

“If you have a reasonably calculated growth plan, no one is going to say keep your head in the sand and wait until Q2 of next year and see where rates are,” Hurn said. “Banks don’t like to lend when the economy is slowing and there are higher rates, which translate to higher risk of defaults.”

Hurn said loan covenants are being “tripped” more frequently now in deteriorating sectors of the economy, though that by no means typifies the credit profile on Main Street.

“Once interest rates go up, and if inflation does not go down, we will see more debt service coverage ratios getting violated,” Arora said. This has to be taken into account because here is a lag between Fed policy decisions and economic impact, and this implies that sticker forms of inflation will last for longer even as sectors like housing and construction are deteriorating.

Much of the surplus liquidity businesses are sitting on due to government support is being eroded, even amid healthy customer demand, because of high inflation. And even if this economic downturn may not be anything like the severe liquidity crisis of 2008, business owners are in a better position when they have the access to credit before the economic situation spirals.

This is not 2008, or 1998

The systemic issues in the financial sector, and the liquidity crisis, were much bigger in 2008. Today, unemployment is much lower, lender balance sheets are much stronger, and corporate balance sheets are stronger too.

“We’re just running into a slowing economy,” Hurn said.

When he started in small business lending back in 1998, business loans reached as high as 12% to 12.5%. But telling a business owner that today, like telling a mortgage borrower that rates used to be much higher, doesn’t help after an artificially low interest rate era.

“Psychologically, people set their expectations for borrowing costs … ‘they will be this cheap forever,'” Hurn said. “It’s changing radically now.”

“If rates go close to 10%, psychologically, businesses will start hesitating to borrow,” Arora said.  

And with a peak Fed rate level of 4% or higher reached by late this year, that is where SBA loan rates are heading.

The problem of higher interest rates and recession

Another 150-175 basis points in total from the Fed, if it has its intended effect of bringing inflation down, would leave many businesses in a stable condition because all of the other costs they are facing outside of debt would be more manageable. But the key question is how quickly the interest rate actions bring down inflation, because the higher rates will impact the cash flow of businesses and their monthly loan payments.

Lower inflation in stickier parts of the economy, like labor, combined with energy costs remaining lower, would allow small businesses to effectively manage cash flow. But if those things don’t happen as quickly as people are expecting, “then there will be pain, and consumer spending will be down too, and that will have a bigger impact,” Arora said. “The challenge is recession and high interest rates together that they have to handle and haven’t seen in 40 years,” he said.

Rates are not ordinarily considered the determining factor in a business’s decision to take out a loan. It should be the business opportunity. But rates can become a determining factor based on the monthly repayment amount, and if a business is looking at cash flow against monthly costs like payroll being harder to make, expansion may have to wait. If rates go up enough, and inflation doesn’t fall off fast enough, all borrowing may need to be applied to working capital.

One thing that won’t change, though, is that the U.S. economy is based on credit. “People will continue to borrow, but whether they can borrow at inexpensive rates, or even get capital trying to borrow form traditional sources, remains to be seen,” Hurn said.



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