Consumers may soon see the most aggressive Federal Reserve in decades.

The US central bank is increasingly expected to raise interest rates this year to the highest since 2005. How much depends on who you ask: Goldman Sachs plans seven increases, while traders are betting on at least six, according to CME Group’s FedWatch.

Others are beginning to speculate that a nasty January inflation reading could prompt the Fed to start its tightening cycle with a bang: a whopping half-point hike, the biggest since May 2000.

To make 2022 an even busier year for Fed policy, a number of officials expect to start trimming their massive portfolio of nearly $9 trillion in bonds by later this year. year, according to the minutes of the Fed’s January meeting.

The ultimate risk, however, is that the US central bank will do more harm than good to an economy that is already experiencing its worst inflation since 1982.

Controlling inflation is a priority for Fed officials as price gains nearly quadruple the Fed’s target and show no signs of slowing. But the danger is that the Fed could force its way into a slowdown, squeezing the brakes on the economy too quickly and zapping too much liquidity all at once. Fiscal stimulus is also fading, while the economy is expected to return to trend growth over the next two years, a pace destined to be historically tepid given longer-term trends of population aging and globalization.

“The economy doesn’t need the training wheels anymore, but you don’t want to just rip them off,” says Ryan Sweet, senior director of economic research at Moody’s Analytics. “The Fed has to adapt to this. It will be a very difficult year.”

Markets fear defeating inflation will mean triggering a recession

Fears of a recession are widespread at the moment. One such example: the 10-year Treasury yield is not steepening at as rapid a pace as the 2-year rate, adding to signs that the latter yield may soon overtake the other. Known as the yield curve, the difference between these key bond yields has long been used as an indicator of Wall Street’s recession. When we go back, it shows that investors are expecting a slowdown.

Markets have also been uneasy so far in 2022 as investors grapple with those creating recession risks. In late January, the S&P 500 fell almost 10%, but has since recovered about a fifth of the lost ground. A Chicago Board Options Exchange market volatility tracking index is up more than 69% so far this year.

Part of the worry about inflation from the start has been that a slowdown is its only remedy, likely informed by the markets’ bad experiences during the stagflationary era of the 1970s and 1980s.

At the time, the Fed fabricated what was at the time the worst recession since the Great Depression, raising its benchmark borrowing rate to a target range of 15-20%. The idea that expansions don’t just die of old age has long been tradition on Wall Street.

“Not only is it a concern, but the odds favor it,” says Greg McBride, CFA, Bankrate’s chief financial analyst, referring to recession risks. “Look at the last three [tightening] cycles: two of them ended in recessions, and the one that didn’t was an economic downturn, where they had to reverse course and start cutting rates. History is not on their side.

How aggressive will the Fed be in raising rates in 2022?

That could be a point in favor of aggressively exiting in March, McBride says. Raising interest rates in one or two half-point moves could give the Fed more time to wait and see how the economy plays out.

“An ounce of prevention is better than cure,” he says. If the Fed takes rate hikes, “it doesn’t need to keep raising interest rates that long or raise them that high and flirt with much bigger economic fallout.”

Whether the Fed goes big in March or later will depend, in part, on the consensus. St. Louis Fed Chairman James Bullard has shown support for an aggressive Fed move, saying in a Feb. 10 Bloomberg interview that he would like to see rates rise 100 basis points by July. Other corners of the Fed, not so much.

“Sharp and aggressive action can actually have a destabilizing effect on the growth and price stability that we are trying to achieve,” San Francisco Fed President Mary Daly said in a CBS interview on May 13. February. She hinted that she favored a more modest move in March and then leaving other moves until the data.

Some officials in the Fed’s January minutes expressed the same concern. Fed Chairman Jerome Powell himself made no commitments. The chief central banker said at the press conference following the January meeting – his last public appearance – that officials have not made any decision on whether they would prefer to raise with a move of a half -point. Instead, he preached that the pandemic had humiliated the jobs of policymakers and acknowledged that the economy can evolve in ways officials did not expect.

Fed rate moves hinge on inflation and jobs data

Officials, however, discussed at the January meeting the removal of housing “at a faster pace than they currently expect” if inflation does not come down. All of this shows that the pace of the Fed’s rate hikes depends on how the economy develops.

In December, Fed policymakers saw inflation dip to 2.6% later this year, although that was before the Labor Department’s consumer price index (CPI) showed only prices rose 7.5% in January.

While some downward movement is expected as the pandemic and supply chain bottlenecks ease, the prospect of inflation persisting longer is also high. Many workers are beginning to demand wage increases to account for the rising cost of living, while a historically tight labor market has led many companies to raise wages. A tracking measure of employer compensation costs rose 4.5% in the last three months of 2021, the highest on record.

Even more blockbuster, employers added 467,000 positions in January, suggesting that hiring remained resilient despite an increase in new virus cases during the Omicron wave.

The Case for Patience: Rate Hikes Take Time to Impact the Economy

On the other hand, higher interest rates take time to trickle down to the economy. Experts say it may take a year for the full effect of a rate hike to materialize, raising the risk that the Fed will tighten too much. This could lead the Fed to take a less aggressive stance, increasing by a quarter point in March.

“If you balance the risks and worry less about a slowing economy and more about inflation remaining high and becoming part of the price and wage setting process, you might conclude that you need to act faster. “, says Bill. English, professor of finance at the Yale School of Management who spent 20 years at the Fed. “The lags only make it harder because you have to be forward looking and judging how the economy is going.”

What to do with your money when rates are expected to rise

It is not a question of whether rates will increase, but by how much. Take steps now to prepare your finances for a new era of monetary policy, which will mean higher borrowing costs in the future.

• Repay the debt: Consumers with fixed-rate debt won’t feel any impact from a Fed rate hike, but you’re more vulnerable if you have a variable-rate loan. Prioritize paying off that debt, especially a high-interest credit card balance. Consider consolidating that debt with a balance transfer card or helping you reduce your main balance further. Homeowners with an adjustable rate mortgage or home equity line of credit (HELOC) might be advised to refinance to a fixed rate loan. “You don’t want to be a sitting duck for higher interest rates on your credit card or home equity line of credit,” says Bankrate’s McBride.
• Take steps to strengthen your revenue opportunities: Now is the time to start maximizing your income to hopefully beat inflation. Take advantage of a historically tight labor market to negotiate higher salaries. This could involve looking for a new position, which has been known for giving workers bigger pay gains.
• Boost your emergency savings and find the best place for your money: High inflation should not prevent consumers from building up a contingency cushion in case of emergencies or unexpected expenses. In fact, rising recession risks only underscore the urgency. However, shop around for the best yield in the market. Online banks tend to offer higher returns for your money than traditional brick-and-mortar institutions.
• Think about protecting your finances against the recession: Since many risks await the Fed, always be on the lookout for how you can protect your finances against recession. In addition to building your emergency fund, experts say it’s about living within your means, staying connected to your network, identifying your risk tolerance and staying focused on the long term, if you are an investor.

“It will be a very difficult task to land this plane perfectly on the tarmac,” Moody’s Sweet said of the Fed’s efforts. “There’s going to be a lot of jerks, where the Fed has to pull back on rate hikes or accelerate rate hikes. It’s very different from the last tightening cycle.

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