Key Takeaways
The FOMC is expected to keep interest rates at 23-year highs at its next meeting, and may cut rates less or not at all, compared to the three cuts it had expected in 2024. The reasons for the cuts are more important than the timing, with a gradual economic slowdown being the preferred scenario. Consumers should focus on paying down high-interest debt and building emergency funds.
Federal Reserve officials may have unwittingly likened themselves to airline pilots when they began raising interest rates for the first time in 40 years, aiming to give the U.S. economy a “soft landing” by gradually slowing growth.
But rising inflation has forced policymakers to postpone rate cuts, and the analogy remains the best way to describe what's happening at the U.S. central bank, especially now that rates and interest rates appear to be stagnating.
The Federal Open Market Committee (FOMC) is expected to keep borrowing costs unchanged at a 23-year high of 5.25% to 5.5% when it next meets in June, where the key benchmark interest rate has been kept since July 2023.
Interest rates mimic reality. It's been almost a year since the Fed last touched interest rates, and price pressures haven't improved for nearly 12 straight months. Inflation hit a two-year low of 3% in June 2023 but has since risen, most recently reaching 3.4% in April. A new report, due to be released on the same day as the Fed's interest rate decision, could signal continued stubbornness.
These inflation surprises have forced the Fed to tweak its interest rate plans in the same way that a captain adjusts his flight path. At the start of the year, most economists were debating whether the Fed would start cutting interest rates by its June or July meeting, citing the rapid slowdown in inflation. Today, they are debating whether the Fed intends to cut interest rates at all. This is despite the fact that the Fed's overseas counterparts, the Bank of Canada and the European Central Bank, have already begun the easing process with interest rate cuts.
Stable rates mean the same for consumers: Interest rates on mortgages and credit cards are likely to remain high, underscoring the importance of paying down high-cost debt, but savers still have time to take advantage of the highest yields in a decade.
Inflation may not be coming down as fast as we would like, but the economy is not worsening as much as expected. I think this is preferable to inflation going back to 2% and the economy collapsing. — Greg McBride, CFA, chief financial analyst at Bankrate
1. The Federal Reserve will likely plan fewer interest rate cuts in 2024.
What will be most interesting at the next Fed meeting is not what officials will do with interest rates but what they will say about them.
Policymakers are expected to update their refined Summary of Economic Outlook (SEP) to communicate to consumers and investors their expectations for the economy, growth, unemployment, inflation and interest rates over the coming year.
The last time officials updated these estimates, Fed policymakers' median estimate suggested three rate cuts were on the way in 2024, but the reality is that's still unlikely to happen for a reason even simpler than stubborn inflation: math.
After the Fed's announcement scheduled for June, officials will have just four policy meetings left. Economists say rapid-fire rate cuts are probably not needed at a time when economic growth remains strong and inflation remains high. In other words, three rate cuts in four meetings might give the impression that Fed policymakers think they need to ease monetary policy sooner.
“The economy has often performed better than expected in recent years,” McBride said. “At this point, there isn't necessarily a lot of compelling evidence that anything more than a slowdown in the pace of economic growth is likely.”
A dovish outlook would suggest two rate cuts in 2024 are still on the table, while a forecast of just one cut or no cuts would be seen as more hawkish.
“I expect the first rate cut to come in the third quarter,” said Christina Hooper, global market strategist at Invesco, who forecasts two rate cuts in 2024. “September seems more likely than July, but I still expect July to be an option.”
2. Why the Fed cuts interest rates may be more important than when it does so.
But most investors and consumers seem to be very focused on the timing of the rate cuts, and more importantly, the reasons for them.
The best-case scenario remains that inflation will move toward the Fed's 2% target without hurting the job market, and Fed officials will begin to gradually lower interest rates. But a more worrying reason to cut rates is a weakening economy.
Notably, Fed officials acknowledged at their last rate-setting meeting in May that they believed a slowdown in the labor market was reason enough to cut interest rates, even if price pressures remained higher than desired.
“I think there are other paths the economy could take;
“We would like to consider lowering interest rates,” Powell said at a news conference after the meeting. “Two paths to doing so would be if we had greater confidence that inflation is declining sustainably to 2 percent, and another would be if the labor market weakened unexpectedly.”
Growth appears resilient, but economists can cherry-pick reasons to worry.
Job openings have fallen sharply by 8 percent so far this year, bringing the job openings per unemployed person back to pre-pandemic levels, according to Labor Department data.
In another worrying sign, the unemployment rate hit 4 percent in May, the highest level in more than two years, ending the longest stretch of unemployment below 4 percent since the 1960s.
Yet hiring has been historically strong and the unemployment rate remains at an all-time low. The Fed's estimate of the long-term unemployment rate, often considered the natural level, or “full” employment, is 4.1%. Needless to say, the Fed is trying to slow the economy by raising interest rates, and believes that cooling inflation is worth the cost.
But the longer interest rates remain high, the greater the pressure on the U.S. financial system. The San Francisco Fed estimates that the benchmark federal funds rate, adjusted for inflation, will reach 6.27%, the highest estimate since 2009.
“The labor market appears to be roughly in balance, but the Fed needs to walk a tightrope,” said Ryan Sweet, chief economist at Oxford Economics. “If we wait for concrete evidence that the labor market is distorted, it's too late.”
Federal Reserve's latest comments on interest rates and the economy
I've said publicly before that I was at the midpoint, 3%. I don't think that's appropriate yet, given the developments we're seeing in the economy. — Loretta Mester, Cleveland Fed President I'd like to have all the data by the next FOMC meeting to draw a conclusion, but I can say this: We definitely won't be cutting rates more than once. — Neel Kashkari, Minneapolis Fed President It's too early to think about cutting rates. We need to see some of this uncertainty about the path we're on resolved. — Laurie Logan, Dallas Fed President Their total interest burden is still not historically high, because pandemic-era debt repayments and refinancings have protected consumers and businesses from higher interest rates. To me, that suggests the full impact of higher rates is still to come. — Thomas Barkin, Richmond Fed President
3. It is becoming harder to tell the difference between an economy that is normalizing and one that is prone to recession.
The US economy's post-pandemic boom wasn't expected or even thought to last forever. Workers had more bargaining power to switch jobs and get higher wages than they have in years. But it came at a cost: the highest inflation in decades.
“The economic slowdown appears to be orderly, but it can still be unsettling,” Sweet said.
Fed officials are going to let some air out of the balloon to tame inflation, even if they don't want to let too much air out of it. But it can be hard for economists and Fed officials themselves to decide whether the slowdown is healthy or something to be more worried about.
Take Chicago Fed President Austin Goolsby: In response to a question from Bankrate about rising consumer loan delinquency rates, the Fed official said he wasn't worried about the level, but the rate of change was.
“When consumer loan delinquencies start to rise, that's often a leading indicator that things are going to get worse,” Goolsby said during a panel hosted by the Society for the Advancement of Business Editing and Writing. “When I give those levels and compare them to pre-COVID levels, we don't see a lot of difference.”
The same can be said about the unemployment rate, which has averaged 5.7% since 2000 and has stayed above 6% even outside of recessions. A 4.5% unemployment rate might not be historically high, but it would be an undeniable slowdown compared to the half-century low of 3.4%.
“We're up half a percentage point from the lowest level in more than 50 years, but is that something to be worried about?” McBride said. “It's a hard debate to have when unemployment is 4 percent. It would be a hard debate to have if unemployment was 4.5 percent.”
What the Fed's next announcement means for you
Interest rates remaining high for an extended period of time means consumers need to pay down high-interest debt, build up emergency funds and have a plan in place to adequately cover unexpected expenses.
Banks have been offering the highest yields on consumer deposits for over a decade. According to Bankrate's latest ranking, the online bank with the highest yield is currently offering an annual interest rate of 5.55%. Another benefit of a high yield is that it helps you grow your funds more quickly to use for unexpected expenses or your team's long-term goals. At current levels, a 5.55% annual interest rate can generate $555 in interest over one year on a $10,000 deposit. Customers still have the opportunity to lock in these high yields for the long term through negotiable deposits (CDs). As the Fed appeared to be about to lower interest rates, the yields on 5-year and 1-year CDs were dropping rapidly. Since then, yields have stabilized and, most importantly for consumers, continue to outpace inflation. The best 1-year CDs can secure an annual interest rate of 5.36%, and 5-year CDs currently pay the highest yields at 4.55%. If you're okay with keeping your funds locked up, these yields could help you lock in a decade-high yield even when interest rates eventually start to fall. A big jump-start on your debt repayment plan is balance transfer cards, which currently offer introductory rates of up to 0% annual percentage rate (APR) for about 21 months, according to Bankrate's latest findings. Meanwhile, 30-year fixed-rate mortgages are unlikely to drop significantly unless there's more evidence of slowing inflation. According to Bankrate's 2024 forecast, borrowing costs are expected to remain at their highest in the past decade, even if the Fed cuts rates twice.
“Interest rates aren't going to come down fast enough or quickly enough to save you,” McBride said. “As a borrower, you're going to have to do the heavy lifting of paying down your debt.”