The Federal Reserve has made significant progress in tackling inflation, with inflation falling 0.1 percentage point from April to 3.3% in May. Following this slight decline, the Fed decided to keep its target interest rate in the 5.25% to 5.50% range at its June 2024 meeting.
The Federal Open Market Committee, the Fed's interest rate-setting body, said in a press release about the rate decision that it “judges that risks to the achievement of our employment and inflation objectives have moved more balanced over the past year,” but that “the economic outlook remains uncertain, and the Committee remains very vigilant about inflation risks.”
“The Committee does not consider it appropriate to lower the target range until it has greater confidence that inflation is moving sustainably toward 2 percent,” the press release said.
Fed waries inflation, but rate hikes likely to end
The Fed began a series of rate hikes in March 2022, when inflation was at 8.5%, raising its target rate from 0% for a total of 11 hikes by July 2023. Since then, the Fed has kept interest rates steady.
While raising interest rates has had the desired effect of lowering prices, the Fed has not let its guard down in its fight against inflation, which rose to its highest level in more than 40 years in 2022. The Fed will not let its guard down until it is sure it has defeated this demon.
In 1980, inflation reached 11% under Fed Chairman Paul A. Volcker. (The Fed's rate hikes then pushed the economy into recession, a scenario that hasn't played out this time.) Learning from that lesson, the Fed is now focused on not cutting its target rate until it is confident that inflation is under control, to discourage consumers and businesses from expecting higher inflation in the future.
Pandemic-related effects cause inflation
The Fed's series of rate hikes since March 2022 were aimed at combating post-pandemic inflation. Supply chain disruptions and stimulus measures implemented during the pandemic, as well as the effects of the war in Ukraine (which affected the price of crude oil and other commodities), have fueled inflation, and the Fed has focused on raising its target rate to combat the effects of inflation that have proven more robust than the central bank had anticipated.
After the coronavirus pandemic began in 2020, the Federal Reserve began cutting interest rates, effectively slashing its target rate to 0%. These low rates were intended to stimulate consumption and business investment to keep the economy moving smoothly as it recovered from the crisis.
The Fed also intervened to buy mortgage-backed securities and Treasury bonds, which also had the effect of injecting money into the economy and lowering interest rates, and took additional steps to prevent financial markets from freezing.
Now, through a policy known as quantitative tightening, the Fed is gradually shrinking its balance sheet of acquired securities, a move that will suck money out of the economy and further support the Fed's policies by pushing up interest rates as the money supply shrinks.
Employment and inflation targeting
The Fed's actions are guided by a dual mandate to manage both employment and inflation to optimize economic performance: its objectives are to maximize employment and promote price stability while maintaining inflation at 2% in the longer run.
In 2020, the Fed decided to keep interest rates low even as employment grew, making the labor market more inclusive and allowing disadvantaged groups to get jobs. This was mindful of lessons learned after the 2008 recession, when inflation did not pick up despite continued job growth. The Fed was not expected to raise interest rates until 2023, but inflation concerns surfaced, leading the central bank to accelerate its tightening cycle in March 2022.
Given the lingering inflation caused by the pandemic and exacerbated by the war in Ukraine, the Fed is now focused on containing inflation to prevent expectations of higher inflation from taking hold in the minds of consumers and businesses. The October 2023 attack on Israel by Hamas has also increased geopolitical tensions.
Additionally, the labor market remains strong, even as rising interest rates have kept inflation in check. Employment increased by 272,000 in May, while the unemployment rate remained low at 4.0%. Average hourly earnings increased 4.1% in May compared to the previous 12 months. Additionally, the government revised employment numbers for March and April, meaning that the number of new jobs added over those two months was 15,000 fewer than previously reported.
Consumers expect lower inflation
When it comes to inflation, consumers don't seem to be wedded to the idea that current high inflation levels will continue. A University of Michigan survey found that consumers expected inflation to rise to 3.3% in May, up from 2.9% in March. The 2.9% forecast was the lowest level in three years for consumers' inflation expectations over the next 12 months.
Impact on credit card interest rates
What all this means for cardholders is that variable card interest rates are likely to remain at their current high levels for some time. Credit card interest rates are tied to the prime rate, which issuers add a markup to to calculate their card's interest rate. The prime rate is based on the Federal Reserve's target interest rate, which means that if the Fed starts to raise its target interest rate, the prime rate will rise as well.
And when the prime rate rises, variable rates quickly follow suit. In fact, credit card interest rates have been rising for the past two years, but they started to fall again a few weeks ago. The national average APR was 20.68 percent in early June, up slightly from 20.66 percent in May.
This means you need to start managing your credit card balances more strategically. If you have a balance, create a repayment plan. If you're going to carry a balance for a while, you can move to a lower-interest option, like a balance transfer credit card with a 0 percent introductory APR.
If it is more advantageous to take out a personal loan to pay off your credit card debt, you may want to consider doing so. Home prices have skyrocketed in recent years, and homeowners may want to consider taking out a mortgage to pay off their credit card debt. Another option is to take on a side job to earn additional income and use it to pay off debt.
Conclusion
The Federal Reserve maintained its target rate in the 5.25% to 5.50% range at its June 2024 meeting, but it has not declared victory in the fight against inflation. However, the Fed appears to be done raising its target rate this cycle and expects one rate cut in the second half of 2024.
Because variable credit card interest rates are tied to the prime rate, which is based on the federal funds rate, consumers should prepare for variable rates to remain at their current high levels for some time. This means that if you have a credit card balance, you should be strategic about paying the lowest interest rate you qualify for.