Share this article

print logo

Another Voice: Future rate increases will be guided by inflation

By Anthony J. Ogorek

After nearly a decade of falling interest rates, the Federal Reserve raised the overnight rate for banks lending to each other by 0.25 percent. This move, while not significant in and of itself, signals that the Fed believes the economy is strong enough to withstand a sustained rise in rates.

The Fed’s projections for economic growth have historically been as accurate as a winter storm warning in Buffalo. Sometimes they are right, frequently they are wrong. Consumers may not have much to fear concerning higher rates in the future based on our reading of the tea leaves. There are a number of forces that portend a muted rise in rates going forward.

After the Fed’s much-delayed rate increase last month, the questions on the minds of most people are, how far will the Fed go, and how quickly will it get there? The consensus is that they expect short rates to rise by a full percent during 2016. The expectation is that the Fed will continue raising rates until the overnight rates reach 3.5 percent.

This may sound like quite an increase from where we have been, however, the target rate is still a full 2 percent below the average for short-term rates over the past several decades.

It remains to be seen how the economy will respond to rising rates. Regardless of the Fed’s wishes or agenda, reality will intrude on the Fed’s plans. The law of unintended consequences is always operative, even if you have a building full of economists using sophisticated modeling tools and work for the most powerful central bank on Earth.

For instance, rising mortgage rates will increase the monthly payment for homeowners who have adjustable-rate mortgages, or for borrowers originating new mortgages. In the current low wage growth environment, rising rates would likely eliminate an increasing number of buyers from homeownership – but not due to the affordability of a mortgage.

When making loans, lenders insist that borrowers maintain specific ratios of income to debt. If your income remains stagnant, the increased debt load imposed by higher rates will cause lenders to disqualify borrowers who cannot meet their debt ratios. People who hold variable-rate credit cards and mortgages will be directly affected by rising short-term rates. These borrowers have caught a break with cratering energy prices. Rising energy prices will surely limit the Fed’s ability to raise rates much in the future.

Wage growth is the primary driver of inflation. In order for the Fed to hit its rate targets, it is imperative for inflation to rise.

Rising U.S. rates will lower the prices of imports. Without higher inflation, rates cannot rise very much. If you want to know where rates are going, watch inflation.

 

Anthony J. Ogorek is founder and chief investment officer of Ogorek Wealth Management in Williamsville.