The Federal Reserve has suggested that the current era of high-interest rates, the highest in two decades, may not be tapering off soon, indicating a significant shift in policy. This comes as recent economic forecasts reveal that borrowing costs are expected to remain elevated for years to come, according to an announcement made on Thursday.
Officials from the Federal Reserve project that their benchmark short-term interest rate will stay above 5% next year and conclude 2025 at almost 4%, nearly double the rate at the end of 2019. Even by 2026, when inflation is expected to be under control and economic growth to stabilize, rates are predicted to remain well above pre-pandemic levels.
This policy shift is partially attributed to the economy’s resilience against aggressive interest rate hikes over the past eighteen months. The economy’s robustness suggests it can now withstand higher borrowing costs, marking a departure from previous years when even minor increases threatened growth.
The term “Higher for longer” has surfaced on Wall Street as a summary of the Federal Reserve’s new stance. This shift towards elevated rates could significantly impact households, particularly those hoping for 3% mortgage rates. For instance, mortgage rates have surged past 7%, a sharp increase from around 2.7% before the Federal Reserve initiated rate hikes.
Investors who profited from borrowed money during the pre-pandemic “free money” era may face challenges due to these higher rates. Borrowers with large outstanding debts might now reset at higher interest rates, affecting both commercial real estate companies and the US government, which is consistently spending more to service its debt.
The stock index dropped over 1% on Thursday morning following the Federal Reserve’s prediction of sustained high rates. Higher interest rates increase costs for consumers and companies, potentially affecting corporate profitability over time.
However, higher rates could also bring benefits, improving the Federal Reserve’s ability to stimulate growth during economic downturns. Savers who were previously forced to take bigger risks for decent returns could also benefit from higher rates.
Despite these predictions, uncertainties persist. Federal Reserve Chair, Jerome H. Powell, acknowledged that long-term economic forecasts are notoriously unreliable. If economic recovery slows down and unemployment rises, policymakers may have to cut rates more than currently anticipated.
For now, the Federal Reserve predicts that the surge in interest rates will eventually subside, with the estimated “neutral rate” that maintains a steady and sustainable economy remaining unchanged at 2.5%. The question of whether high rates are a temporary or permanent shift remains open.
Economists remain divided on this issue. Some believe that rates are likely to be permanently higher due to increasing government debt and demand for borrowed money. Others point to investments in green energy and new technologies like artificial intelligence as trends that could drive both growth and rates higher. However, some remain skeptical of a long-term shift, arguing that the neutral rate may have only temporarily increased post-pandemic.
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