What the Fed’s new interest rates mean for you and the Houston economy

Why the rate hike?

The Fed is raising interest rates to combat inflation, which has run at an 8.5 percent rate since last year – the highest in four decades. Higher interest rates make borrowing more expensive, slowing consumer and business spending and curbing demand for goods and services. When demand weakens, businesses can’t raise prices as quickly — if at all.

The Fed has set a target of keeping inflation at about 2 percent, which is viewed as ideal to accomplish the central bank’s statutory goals: encouraging maximum employment while maintaining stable prices.

How did we get here?

Inflation’s return has its roots in the pandemic. The rapid spread of COVID-19 in early 2020 shut down much of the global economy, forcing widespread layoffs, disrupting manufacturing and shipping, and battering oil and natural gas production as people stayed home and fuel demand plummeted.

Congress and the Federal Reserve acted quickly to support the economy, pumping trillions of dollars of stimulus into the economy through direct federal spending, interest rate cuts and the Fed’s intervention in bond markets. The policies largely worked, fueling a quick recovery from a deep recession and even lowering the nation’s poverty rate.

Consumers, stuck at home, increased savings. Three rounds of stimulus checks bolstered household balance sheets. As the economy emerged from the pandemic recession, households, flush with case, began spending and spending.

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But producers and shippers weren’t ready for the surge in demand, and were unable to ramp up and bring back laid-off workers quickly. COVID outbreaks still shut down factories. Supply chains got tangled. Demand soon outstripped supply, and prices rose.

These issues played out in spades in the energy industry, where a plunge in oil prices — at one point falling below zero — led companies to shut down wells and slash production. As transportation rebounded, demand rose faster than supplies and prices climbed quickly.

Bill Gilmer, director of the University of Houston’s Institute for Regional Forecasting, said policymakers “reacted too late to the inflation threat,” setting the stage for the rapid rise in prices that has followed the Russian invasion of Ukraine.

What’s the Fed doing?

The Fed is essentially applying the brakes to a speeding economy. In addition to raising its benchmark short-term rate, it is ending bond-buying programs and unwinding its holdings in the bond market, a program the central bank undertook to lower long-term borrowing rates such as mortgages. The challenge for the Fed is to apply the brakes enough to slow the economy’s momentum without bringing it to a stop.

What’s the impact?

Higher borrowing costs. The Fed’s rate increase will directly affect rates for credit cards, home equity lines of credit and other short-term borrowing. It also influences long-term rates, such as mortgages, which reflect investors’ expectations for inflation and interest rates in the future. Long-term rates have already reacted to the likelihood of a higher interest rate environment. Mortgage rates have climbed about 2 percentage points since the end of last year to an average 5.1 percent, according to Freddie Mac, the government-sponsored mortgage finance company.

“Anything that a Houston business or consumer buys on credit will become more expensive,” said Patrick Jankowski, senior vice president of research at the Greater Houston Partnership. “Mortgage payments, car notes, appliances and interest on credits cards will rise. Businesses will pay more to finance inventories, new plants and equipment, office furniture or vehicles — anything they typically secure a loan for rather than pay out of cash flow.”

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Houston’s scorching-hot real estate and construction markets will be directly affected by higher rates, as building becomes more expensive and higher mortgage rates price out some would-be homebuyers, said Parker Harvey, regional economist at Workforce Solutions. An economist at the National Realtors Association estimated that higher rates have cut about 10 percent of Houston buyers from the market. Analysts expect the home sales to fall from record levels this year and prices to rise more slowly.

Houstonians using credit to buy vehicles, appliances and other items will have monthly payments go up to reflect higher interest costs, Jankowski said. And as higher rates curb spending and the economy slows, workers can expect wage growth to slow, too, Harvey said.

Local wages have risen at two or three times the inflation rates for certain occupations, namely those in the transportation sector, food preparation jobs, and clerical or administrative positions. As interest costs rise, and businesses scale back their expansion plans, Harvey said, demand for workers could ease, relieving pressure to pay higher wages, or choose to absorb the additional costs and pass them onto customers. Analysts expected home sales to slow.

Any good news?

If you’re a saver, this is what you have been waiting for. Savings rates, which are tied to the Fed’s benchmark short-term rate, have been at rock-bottom since the Fed has held the rate near-zero for nearly two years.

As the Fed raises its benchmark, savings rates will follow, but likely at a slower pace. But savings accounts will definitely be paying more than the .06 percent national average, according to the personal finance website Bankrate.

As for my portfolio?

Expect more than a few ups and downs as markets adjust to a higher interest environment and investors adjust their bets. Major indexes are down by double-digits since the beginning of the year as investors prepare for slower growth. Interest sensitive industries, such as housing, are likely to take the biggest hits. On the other hand, higher interest rates tend to mean higher profits for lenders, so the banking sector stands to benefit.

The bond market is also taking a haircut. Rising interest rates mean higher bond yields, which lowers the values of bonds. People with bond funds have likely noticed that their values have declined as inflation and rates have risen. The yield on benchmark 10-year treasury earlier this week briefly topped 3 percent for the first time since 2018.

Older investors — particularly retirees or those close to retirement — are most exposed to the bond market, which is viewed as safer and less volatile than stock markets, said Christopher Hensley, CEO of Houston First Financial Group. The silver lining to declining bond values is higher yields, which mean more income.

Recession on the way?

Maybe. Most recessions since the end of World War II have been precipitated by the Fed raising rates to cool hot economies. Right now, most economists expect the economy to slow down as the Fed tightens money, but avoid a recession. The Wall Street bank Goldman Sachs recently put the chances of recession in the next two years at 35 percent.

Jankowski said a recession appears unlikely because of the strength of the economy, which continues to create new jobs as businesses reopen, expand, make new purchases and rebuild inventories that were depleted during the pandemic.

But that doesn’t mean higher interest rates won’t have detrimental effects on the economy, Harvey said. He compared it to adjusting water temperature in the shower.

“If you’re in a hurry you might make bigger adjustments to try and get it to the right temperature in a shorter period of time,” he said. “But you run the risk of an unpleasant surprise, hot or cold.”

Harvey said it’s possible that the Fed waited too long to address inflation and will have raise rates aggressively to bring it under control. He expects the Fed to be “especially vigilant” on inflation over the next few months, but be quick to correct course if there are signs of serious economic slowdown.