Interest Rates and Inflation are Both Up

March 7, 2022

The Federal Reserve said that they will increase interest rates at least three times this year, and possibly more, beginning in March. This will ripple through the economy causing mortgage rates and loan rates to increase. Consumer savings rates will also increase but will lag the Federal Reserve rate increases.

First, what happened? Consumer inflation is the highest it has been in over four decades. This means that anyone less than 40 years old has never experienced this level of inflation. Prices for everything from food to medicine, houses, autos, travel, gasoline and utilities are all elevated. These costs are resulting in higher wages, but so far wage growth is not keeping up with inflation. This means that most Americans are not as well off financially this year as they we were last year.

The reasons for this high inflation are many, but the biggest reason is the very rapid increase in the money supply and the significant deficit spending by the federal government. This creates the classic situation of too much money chasing too few goods. Three other serious problems are supply chain disruptions, labor shortages and inflationary pressures caused by the transition to a non-carbon economy.

The supply chain will adjust over time while the transition to non-carbon energy will be expensive for years. No one knows when more employees will join the labor force but slowing population growth means that a smaller labor force is likely to be a permanent problem.

Given the multiple pressures pushing toward higher inflation, the Federal Reserve is genuinely concerned that inflation will become entrenched and lead to a classic wage price spiral. Unfortunately, the Fed has limited tools to reduce inflation. Their primary tools are an increase in interest rates and a reduction in the money supply.

We as consumers are affected because an increase in interest rates will make loans more expensive and will slow growth in the economy reducing job openings and opportunities.

So, how to respond? If you have an adjustable-rate mortgage, switch to fixed. If your mortgage is 4% or higher, you may still be able to refinance to a long-term fixed rate mortgage. If you are currently out of work or considering a change in employment, go ahead make the move now so you can build tenure before an economic slowdown begins. If you have savings, don’t lock in long term CD or bond rates. You
will have better rate options later this year.

We have lived through inflation before. It causes all sorts of disruptions to prices and markets. We will continue to provide updates and advice as we see what happens next with interest rates.