Relief for long-term borrowers may be short as Fed aims to hike rates to 5.6% this year

For long-term borrowers, Jerome Powell at the U.S. Federal Reserve had some good news and some bad news that could affect Canadians hoping to renew mortgages or extend other loans.

The good news is that the U.S. central bank is following the Bank of Canada's lead and after 10 rate hikes in row, has decided to take a break and leave its benchmark rate at about 5.1 per cent.

But the bad news was that like Powell's Canadian counterpart, Tiff Macklem, who paused rate hikes just to resume them, the Fed expects more increases this year, perhaps reaching 5.6 per cent. In the past, Powell had suggested a Canadian-style pause could be risky.

"We understand the hardship that high inflation is causing, and we remain strongly committed to bringing inflation back down to our two per cent goal," said the Federal Reserve chair in his opening remarks. Powell said that inflation hurts everyone and it hurt the poorest and those on fixed income the most.

Lags and headwinds

Despite what he called the central bank's most important priority of getting inflation down to the target the Fed shares with the Bank of Canada, Powell and the committee that advises him decided to pause.

"In light of how far we have come in tightening policy, the uncertain lags with which monetary policy affects the economy, and potential headwinds from credit tightening, today we decided to leave our policy interest rate unchanged," said Powell at his Wednesday news conference.

But he made absolutely clear it was a pause, not an end to rate hikes.

"Looking ahead, nearly all committee participants view it as likely that some further rate increases will be appropriate this year to bring inflation down to two percent over time," he said.

For anyone who thinks U.S. interest rates hikes stop at the border, it's an unfortunate fact that while Canadian short-term floating rates rise and fall with the Bank of Canada's current policy rate of 4.75 per cent, lenders who offer long-term loans like fixed-rate mortgages underwrite them at the North American price of money benchmarked by the Fed.

Another way to think of it is that the Fed's current interest rates means a lender could get more than five per cent return on safe U.S. government bonds. Why would they risk lending money to you for less?

Ripping off the Band-aid

The other part of the bad news for borrowers is that among the key experts who advise Powell, those "committee participants," none expect interest rates to decline this year. In fact most expect interest rates will rise another half percentage point over the next six months, topping out this year at 5.6 per cent which for many borrowers means mortgage rates well above 7 per cent.

At Powell's Wednesday news conference reporters had two main questions. Why, if Powell and his advisers thought they had more work to do to defeat inflation, didn't they just get it done. A one reporter quipped in his question, "Why not just rip off the Band-Aid and raise rates today?"

The other question was, if Powell was willing to wait for interest rates to take effect, why didn't the Fed just wait a little longer? Powell had answers for both.

The pause, he said, would allow the central bank to take stock, gather information and allow the economy more time to adapt. It is widely accepted that interest rate hikes and cuts operate with a time lag, but Powell said that research on the subject is not conclusive.

Pausing also allowed for the banking sector, which faced turmoil after the failure of Silicon Valley Bank and two others U.S. banks, to stabilize.

But as to why not wait longer and wait for more lagging effects of the long string of rate hikes, Powell said that the Fed was not yet confident inflation would continue to come down at current interest rates.

'Not fixed yet'

There were many good signs, he said. Growth was beginning to slow. Wages were not rising as fast and the labour shortage seemed to be improving. The supply shortages that helped launch inflation in 2021 were getting better "but not fixed yet," he said.

Powell said that while inflation had plummeted from 9.1 per cent at its peak last June to four per cent on Tuesday, there simply weren't enough indications that prices were continuing to decline. He noted that core inflation — the rate with volatile things like gasoline removed — was stuck above five per cent.

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He feared that if people began to think four and five per cent inflation were normal, there was a danger inflation would never come down to his two per cent target.

"If you look at the full range of inflation data, particularly the core data, you just don't see a lot of progress over the last year," he said.

Repeatedly asked what kind of evidence would convince him that rising prices had been conquered he said, "What we'd like to see is credible evidence that inflation is topping out and beginning to come down, of course that's what we'd want to see."

Powell said that back when inflation was shooting up above nine per cent, it was essential for the central bank to raise rates sharply and quickly, even at the risk of overshoot. But now as the target seems within reach there is less need for urgency.

"And ideally, by taking a little more time, we won't go well past the level where we need to go."