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Fed set to begin tapering security purchases in November

Credit cardholders should start preparing for higher interest rates

Summary

Although inflation is up, the Fed is waiting for a more optimal employment market before starting to raise its target interest rate, and that could begin in 2022.

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The Federal Reserve is set to start reducing its purchases of Treasuries and mortgage-backed securities this month, while maintaining its target interest rate in the 0% to 0.25% range.

This action, announced at the November meeting of the Fed’s rate-setting Federal Open Market Committee, comes about as the Fed sees strengthening in economic indicators and employment due to “progress on vaccinations and strong policy support.”

The Fed’s move to begin tightening the easy money regimen it started in 2020 (to combat the pandemic and make credit flow down to consumers and businesses) is likely to begin trickling down to credit cardholders, whose variable interest rates are typically tied to the prime rate that moves with Fed policy.

Credit card consumers should start preparing for their interest rates to go up eventually, and tap into today’s lower rates. The average credit card interest rate is 16.13%, according to CreditCards.com data.

The Fed will continue to monitor the situation, watching for any risks in “readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments” in order to take action, if required.

Inflation will ease down

In a related online press conference, Fed Chair Jerome Powell said that although the Delta variant of COVID held back economic growth in the third quarter, with the leisure and hospitality sectors particularly impacted, he expects a pickup in the fourth quarter and good growth for the year overall.

The Fed’s aim is for long-run average inflation of 2%, and it is prepared to let it overshoot this target for a while, since it ran below target for many years.

Although inflation has risen in recent months, with the Personal Consumption Expenditures index up 4.4% for September, the Fed maintains this increase is temporary. It’s caused by supply chain disruptions and increased demand due to the post-pandemic economic re-opening.

“Global supply chains are complex,” Powell noted. While he expects them to return to normal functioning, he said, “the timing of that is uncertain.”

Still room for improvement on employment front

The Fed is also watching the employment situation, considering its mandate is also to foster optimal employment levels. Powell sees the post-COVID economy as uncharted territory, with a scope for more people to land jobs. So there’s a need for humility in gauging the situation, he said.

Powell still doesn’t believe the economy is at maximum employment. For one, employment market participation for prime-age people remains below its pre-pandemic levels, with joblessness “disproportionately” impacting African American and Hispanic people.

Wages have been going up, but there’s been no evidence yet that they are rising higher than worker productivity, Powell noted. And real wages, after accounting for inflation, are not really growing.

Although inflation has gone up, the Fed is still waiting on employment conditions to become optimal before beginning to tighten its target interest rate. It’s possible that conditions for maximum employment could be reached next year, though – which would set the stage for the Fed to start hiking up its target interest rates.

There’s a need for risk management since the Fed could be inviting significantly higher inflation while waiting on maximum employment. Inflation also has a fallout for consumers in the form of higher prices. For now, “the risk is skewed towards higher inflation,” Powell said, and the Fed will act to curtail this if necessary.

He expects the labor market to improve further as the Delta fallout eases. There is some uncertainty now about the employment situation because people are staying out of the labor market due to care-taking responsibilities and fear of COVID.

“We will hope to achieve significant clarity about the post-pandemic economy over the course of next year,” Powell said.

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