Are the Federal Reserve’s rate increases working?

The Fed’s campaign to slow the economy is gradually taking hold, but officials have been particularly surprised by the job market's resilience.

  • By Jeanna Smialek,
  • The New York Times News Service
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The Federal Reserve this year has raised interest rates at the fastest pace since the 1980s, making it increasingly expensive to borrow money as it seeks to slow consumer and business demand and drive inflation lower.

So far, those moves are making more of a splash than a wave.

The Fed has lifted interest rates to nearly 4 percent this month from just above zero in March, and those moves are clearly rippling through financial markets. The housing market has slowed as mortgage rates have surged, and some specific industries — most notably technology — are feeling the pinch. But other parts of the economy, including consumer spending and the labor market, have proved surprisingly resilient to the central bank’s interest rates changes.

Economists are closely watching for any sign that those areas of economic strength are beginning to crack. Some are warning that the slowdown is coming but will simply take time to fully play out, because the interest rate moves already enacted will take months or years to have their entire effect.

“It just hasn’t moved through the whole economy yet,” Gabriel Chodorow-Reich, a professor of economics at Harvard, said. “There’s contraction in the pipeline — the question is how severe?”

Even so, Fed officials will have to decide how much more they must lift interest rates before they can feel confident that inflation will eventually come back down to their goal of 2 percent. The job market’s trajectory in coming months and the holiday shopping season could help to inform how much further officials believe they have to go.

Here’s where rate increases are having an effect, where they aren’t, and why it matters.

Interest-sensitive sectors are slowing.

What’s happening in the housing market is clear evidence that the Fed’s moves are having an impact. Mortgages are at their most expensive in 20 years, with borrowing costs on a 30-year fixed rate loan hovering near 7 percent. Buyers are giving up as prices remain high and borrowing becomes unaffordable: Pending home sales have swooned, new housing construction has pulled back sharply and existing home sales have fallen for a record nine straight months.

Some experts in the car industry also expect used vehicle demand to wane and prices to fall in the coming months, in part because auto loans have become pricier. Pre-owned car prices already declined notably in October inflation data.

Technology companies are also feeling the pain.

If there’s one industry that shows clear signs of hurting right now, it’s technology.

Part of the pullback is tied to the Fed: Technology stock values are premised on future growth and are particularly exposed to Fed rate moves, and many have taken a hit this year. But beyond that, e-commerce soared amid pandemic stay-at-home orders, and has now returned to a more normal growth path. Company-specific decisions are also roiling the industry: Meta bet big on virtual reality, and Twitter was recently acquired by Elon Musk.

As technology companies confront challenges and changes, some have announced big layoffs, including Amazon (), Meta () and Twitter. But tech companies account for just about 2 percent of the nation’s employment, said Nela Richardson, chief economist at the payroll services and data provider ADP. Even substantial firings in the industry would not be enough to meaningfully cool off the broader economy.

“I don’t think tech is indicative of the broader economy,” Ms. Richardson said. Plus, a layoff is not a life sentence and opportunities for tech workers are plentiful.

“Some of these workers might be absorbed into other jobs and industries.”

The overall labor market still looks strong.

Rate increases have yet to seriously dent the overall job market. Unemployment is hovering near a 50-year low, wages are growing at the fastest pace in decades and job openings still far outstrip those looking for work. While openings are declining and hiring is slowing, job gains remain much faster than what would be needed to keep the jobless rate stable.

“The shocking part is, for as much as we’ve raised rates in six months, we’re really just still not seeing much in the labor market,” Christopher Waller, a Fed governor, said at a recent event.

But the labor market is what economists call a lagging indicator. It slows down only when the broader economy has started to turn. If the Fed waits for the job market to pull back notably to stop aggressively adjusting its policy, it may wait too long.

Consumer spending is “rocking.”

Fed officials are also watching consumer and business spending as they try to get a feel for where the economy is heading. In theory, shoppers should be pulling back as money becomes more expensive to borrow and uncertainty about the future mounts.

But so far, businesses continue to invest, and consumers are hardy. Spending cooled earlier this year but has since picked back up, with retail sales jumping in October. Companies including Walmart (), Macy’s () and Home Depot () have reported healthy earnings in recent weeks and are predicting a decent holiday season, even as Target () struggles to clear the inventory it amassed earlier this year.

“Our customer has proven resilient,” Richard McPhail, Home Depot’s chief financial officer, said on an earnings call this week.

The question is why. Part of it probably owes to strong household balance sheets. Families accumulated $2.3 trillion in extra savings in 2020 and 2021, and were still sitting on about $1.7 trillion in excess savings by the middle of this year, based on Fed estimates. While most of that was held by wealthier households, families in the bottom half of the income distribution had $5,500 in extra savings, on average per household.

The strong labor market also means that overall earnings growth — taking into account hours worked, pay gains and jobs added — is rising faster than inflation. That is helping to sustain demand in the economy.

“Consumer spending is rocking right now,” said Neil Dutta, head of U.S. economics at the research firm Renaissance Macro, pointing to sustained demand for everything from new cars to Taylor Swift concert tickets.

The risk, he said, is that domestic spending appears to be accelerating and global demand may be on the cusp of snapping back, in part as China eases coronavirus restrictions. If that surprises retailers who have braced for a recession, it could lead to new inventory shortfalls.

“It is a very potentially problematic situation,” he said.

Inflation may be coming down, but at a fast enough pace?

This all adds up to a conundrum for the Fed as it decides how high interest rates need to go to restrain demand enough that inflation will quickly come back down to the central bank’s 2 percent target.

On one hand, inflation is beginning to slow — prices are still climbing swiftly, but slightly less swiftly than before. That deceleration is expected to continue. Supply chains are healing, and some companies are beginning to pass their lower costs along to consumers. While soaring rents have pushed up price indexes this year, they are on track to fade next year.

But the question was never whether inflation would come down. Economists always expected that it would. It is how much and how quickly it will drop. And with strong demand and a solid labor market, it could be difficult for price increases to swiftly return to the Fed’s target.

Economists at Goldman Sachs estimate that the Fed’s preferred inflation gauge, stripping out food and fuel costs, will slow to 2.9 percent by next December from 5.1 percent today. That would be way better, but still be notably too fast.

The Fed is trying to thread the needle.

Still, Fed officials do not want to push rates endlessly higher, heedless of how much that could cost the economy, as this year’s policy moves are still only beginning to kick in.

That is why policymakers have come to support slowing down their policy moves. Officials have been moving interest rates up by three-quarters of a percentage point per meeting since June, but investors expect them to slow their rate increases to half a point in December before feeling their way forward in 2023.

Dialing back the pace will give them time to feel out how much more is needed.

“By moving forward at a pace that’s more deliberate, we’ll be able to assess more data,” Lael Brainard, the Fed’s vice chair, said in a speech on Monday.

Yet slowing does not mean stopping. Central bankers have also communicated that they are resolved to keep their foot on the brake until they are convinced that they have done enough — which means rates will probably creep higher than they had expected as recently as September. In recent days, some policymakers have acknowledged that it is possible that rates could climb to — or even above — 5 percent.

Letting up too early, they worry, would allow inflation to become a permanent feature of the American economy, making it all the more difficult to stamp out.

So far, “it appears tighter money has not yet constrained business activity enough to seriously dent inflation,” Raphael Bostic, president of the Federal Reserve Bank of Atlanta, wrote in an essay on Tuesday. “While there are risks that our policy actions to tame inflation could induce a recession, that would be preferred to the alternative.”

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