Borrowing could cost a little more in 2022 should the Federal Reserve follow expectations and begin raising interest rates.
As inflation runs higher, driven by supply chain bottlenecks from the COVID-19 pandemic, economists say it’s just a matter of when — not if — the Federal Open Market Committee (FOMC) begins to raise interest rates.
Paul Isely, associate dean at Grand Valley State University’s Seidman College of Business, sees a “reasonable chance” that the FOMC may act as early as May or June 2022 to increase interest rates. If not, any move would likely wait until after the 2022 midterms in November, since the Federal Reserve typically avoids any perception of trying to influence election outcomes, Isely said.
If the economy stays strong and inflation climbs higher, the Federal Reserve could raise rates in early summer.
“Otherwise they’ll drag their feet until later in the year. If they don’t change rates by early summer, unless the wheels are coming off the economy, they’re going to be hard-pressed to want to change them before we reach November” next year, Isely said.
Should the FOMC raise rates in the spring, Isely expects another increase before the end of 2022. If not, expect two increases “in pretty quick succession” late next year, he said.
Leading up to next summer, Isely anticipates “slight drifts” upward in long-term interest rates, “just because people will be getting ready for the change,” he said.
Interest rate ‘liftoff’
While the Federal Reserve has traditionally increased interest rates as a tool to ease strong economic growth and demand and to curb inflation, the present situation results from tight supplies rather than high demand, Isely said.
“We’re not seeing the growth that’s happening right now as really indicative of them wanting to come in and slow things down,” he said. “A good chunk of the price increase right now is a supply-side increase, as opposed to a demand-side increase. Monetary policy is not very effective against supply-side increases.”
Economists at Comerica Inc. forecast the FOMC will keep interest rates at present levels for another year unless inflation remains elevated.
Writing in a Nov. 8 updated U.S. economic outlook issued two days before the latest inflation report, Comerica economists noted how the Federal Reserve this month took “another milestone step toward monetary policy normalization” by tapering its asset purchase program to support the U.S. economy. That sets the stage for an eventual increase in interest rates a year from now, according to Comerica.
“We expect tapering to continue through the first half of next year until the Fed’s balance sheet is stabilized. That milestone will start the countdown toward interest rate liftoff from the zero lower bound,” Comerica economists wrote in the updated outlook. “For now, we are maintaining our forecast for liftoff in December 2022. But an increase in the pace of tapering this spring could signal that the Fed is concerned about inflation and wants to pull liftoff forward.”
Comerica presently forecasts the FOMC to make a 0.25-point increase in the federal funds rate — the interest rate at which commercial banks borrow and lend to each other overnight — by the first quarter of 2023.
As well, PNC Bank forecasts that the FOMC will start raising the federal funds rate in late 2022.
Inflation metrics ‘remain hot’
Both recent outlooks by PNC and Comerica expect the consumer price index (CPI) to remain higher in 2022 than it has been for several years.
Comerica forecasts a 5.3-percent increase in CPI for 2022, up from a predicted 4.6 percent for 2021 and 1.2 percent in 2020. Comerica economists in this month’s updated outlook wrote that “inflation metrics remain hot, fueled by both supply-chain constraints and recent gains in energy prices.”
A Nov. 10 U.S. Bureau of Economic Statistics report had the CPI increasing 6.2 percent in October, the largest rate in more than 30 years.
The producer price index (PPI), which measures the average changes in prices paid to domestic producers, increased 0.6 percent in October and was up by 8.6 percent over the past 12 months, according to the U.S. Department of Labor. Excluding energy and food costs, the PPI was up 0.4 percent for October and 6.2 percent over 12 months.
The Federal Open Market Committee last raised interest rates in early 2015 after nearly eight years of record lows, then started cutting slightly in 2019 as economic growth eased. When the U.S. economy fell sharply in the second quarter of 2020 with the onset of the COVID-19 pandemic, the committee lowered the federal funds rate back to zero.
Preparing for a raise
In early 2021, the general view was that as the economy recovered from the deep 2020 downturn, the committee would not start to increase interest rates at least until after 2023, said Nick Juhle, vice president and director of investment research at Greenleaf Trust in Kalamazoo. The Fed now indicates that interest rates may start to rise in the third quarter of 2022, Juhle said.
“From there, it’s going to depend on how effective the rate increases are at tamping down inflation,” he said. “If a quarter point doesn’t have much of an effect on inflation, you can expect to see them move further.”
Bond markets have already begun pricing for two quarter-point rate increases in the latter half of 2022, Juhle said. He “wouldn’t be surprised” if the federal funds rate — now at zero — moves to 1.5 to 2 percent by the end of 2024 if the economy continues to grow, “with an eye toward going up above 2 percent beyond that timeline.”
Even with increases in the next few years, Juhle points out that interest rates would remain comparatively low historically and “very accommodative, but not as accommodative it recently has been” for borrowers, he said.
Lenders say that increasing interest rates, presuming they are modest, should not affect commercial borrowing. Businesses would likely still proceed with equipment purchases or building an addition to add capacity even if it costs a little more, according to lenders.
“I don’t think modest increases are going to slow down plans,” said Rick Dyer, community president at St. Joseph-based United Federal Credit Union. “I don’t see interest rates now or potential modest increase in interest rates having any kind of significant or detrimental effect in the commercial loan area.”