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Yet Another Rate Hike

 

Key Points

  • 3/4 of a percentage point rate increase
  • Consumer price index has receded from its peak of 9.1% in June to 8.2% in September
  • Non-farm payrolls grew by 261,000 in October, better than the estimate for 205,000
  • Big job gainers by industry included health care, professional and technical services, and leisure and hospitality
  • Personal income increased $78.9 billion (0.4 percent) in September
  • The tax benefits of Section 179

A Substantial Increase

The Federal Reserve announced on Wednesday, November 2, 2022 that it is raising interest rates by 3/4 of a percentage point in an attempt to apply the brakes to inflation. It warned that rates will have to go even higher to bring stubbornly high inflation under control.

The Fed’s traditional reaction towards inflation is increasing the short-term borrowing rate for commercial banks. Banks pass those increased rates to borrowers looking to take out personal or commercial loans. Borrowing money becomes more expensive, forcing companies to consider any significant move. The strategy pulls cash out of the economy and with any luck decreases inflation. However, inaction comes with its own risks as small businesses jockey for position in the economic recovery.

As the Fed continues to raise interest rates in 2022 to combat inflation, small business leaders must keep a close eye on the market and act to improve profitability into 2023.

The Fed has now raised rates six times this year. The benchmark interest rate was near zero in March. Since then, it has jumped 3.75 percentage points in the last eight months.

This is a significant increase. How does the Fed know that a 3/4 of a percentage point increase is the correct amount? It’s the most aggressive series of rate hikes in recent memory, but so far it’s done little to curb inflation. The Fed’s willingness to use multiple rate hikes over a longer time period raises concerns of a possible recession on the horizon.

Mike Regan, Senior Markets Editor for Bloomberg News, states, “The Fed has two goals in mind when they are setting interest rates – one is to maximize the employment situation in the county and there’s no worry there. The market is still red hot in the U.S., but the other goal is to keep inflation anchored at around 2% and it’s very far from mission accomplished on that front.”

The consumer price index has receded from its peak of 9.1% in June to 8.2% in September with a substantial way to go in order to meet the Fed’s 2% goal. What are the next plays for Jerome Powell, Chair of the Federal Reserve, moving forward? He warned that taming such severe inflation will likely require even higher interest rates than he and his colleagues had predicted earlier this year. Many analysts looking forward assume the next rate hikes will be smaller around a half percent instead of the larger hike that we’ve just seen.

Inflation Reduction Will Take Time

The Fed’s goal is to keep raising interest rates to slow economic activity and take the steam out of consumer prices. The economy continues to power ahead even though the Feds have been taping the brakes since March.

“What I’m trying to do is make sure our message is clear,” Powell told reporters Wednesday. “We have some ground to cover with interest rates before we get to that level that we think is sufficiently restrictive.”

On Wednesday, Powell said that he sees no reason to slow the pace of interest rate hikes, even as the central bank tightens credit at its fastest pace since the early 1980s.

“It was what everyone was expecting,” said Jeffrey Frankel, co-president at Stuart Frankel & Co. “What Powell is saying after the announcement, that he will be flexible about future rate hikes, the market seems happy at the moment.”

“In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments,” bank officials said in a statement released at the end of the Fed’s two-day policy meeting.

They admit that curing inflation isn’t accomplished overnight and that it may take many months to move the needle. It’s a guessing game. After making a rate change, the Feds monitor the economy for the consequences of the increase.

It’s not a quick fix, but there are rapid reactions. A noticeable change in mortgage rates which have risen in the neighborhood of 7%. It may take several months for the effects of these higher rates to cool the overall economy. The housing market has already slowed to a crawl. Mortgage and other interest rates may creep a little higher but most analysts believe the worst is behind us.

“Interest rates have risen at a whiplash-inducing speed, and we’re not done yet,” said Greg McBride, chief financial analyst at Bankrate. “It’s going to take some time for inflation to come down from these lofty levels, even once we do start to see some improvement.” He also states in order to curb inflation, borrowing costs will likely have to remain elevated for an extended period.

The increased cost of borrowing has slowed the housing market and other parts of the economy are beginning to slow as well. However, consumers are still flushed with cash and continue to spend money. This may prompt the Fed to tap the brakes a little harder for longer than it may wish.

“We see today that there is a bit of a savings buffer still sitting for households, that may allow them to continue to spend in a way that keeps demand strong,” said Esther George, president of the Federal Reserve Bank of Kansas City. “That suggests we may have to keep at this for a while.” George is focused on inflation reduction, but is also cautious against raising rates too quickly in this uncertain time.

“I have been in the camp of steadier and slower rate increases, to begin to see how those effects from a lag will unfold,” George said. “My concern being that a succession of very super-sized rate hikes might cause you to oversteer and not be able to see those turning points.” With the possibility that aggressive rates hikes could put millions of people out of work, George is understandably cautious.

Personal Income Rises More than Forecasted

Job creation is the foremost indicator of consumer spending, which accounts for the majority of economic activity.

Wages and salaries in both services-producing industries and goods-producing industries have increased. Personal income in the U.S. increased by 0.4 percent in September which was slightly above market expectations of 0.3 percent. According to estimates released by Bureau of Economic Analysis, personal income increased $78.9 billion in September. Disposable personal income (DPI) increased $71.3 billion (0.4 percent) and personal consumption expenditures (PCE) increased $113.0 billion (0.6 percent).

Even though October had the the smallest monthly jobs gain for the US economy since December 2020, job growth was stronger than expected. The Labor Department reported that non-farm payrolls grew by 261,000 for the month while the unemployment rate moved higher to 3.7%. Economists had predicted the figure would climb to 3.6%. Figures continue to point to a strong albeit slowing labor market, as workers shortages persist. Hiring remains robust with stronger than expected job growth in October despite the Federal Reserve’s interest rate increases aimed at slowing what is still a strong labor market. The Fed projects that unemployment could rise beyond 4% next year as interest rate hikes pressure the economy, but so far that isn’t happening. That’s good news for workers, not so much for the Fed or investors.

The U.S. participation rate which measures the share of working age Americans, either working or looking for work, stood largely unchanged at 62.2%. Higher participation could ease wage pressure.

Industry winners: Health care led job gains, adding 53,000 positions, while professional and technical services contributed 43,000, and manufacturing grew by 32,000. This likely wouldn’t be the case if the economy were slowing. The current pace of wage gains is well above what would be consistent with the central bank’s 2% inflation target. Demand for jobs is still strong, yet many analysts view the labor market as overheated and anticipate a shift in demand soon. If you’re hoping for things to slow down or the Fed’s hikes to take hold, you’ll want to see these numbers drop. The last three months of data combined show a very solid labor market likely at odds with the Fed’s plans to combat inflation.

Hands On The Wheel

“No one knows whether there’s going to be a recession or not, and if so how bad that recession would be,” Powell said. “Our job is to restore price stability so that we can have a strong labor market that benefits all, over time.”

Prepare For 2023 With New Or Used Equipment

Are you considering adding equipment? Proper equipment gives companies the capacity to better compete for consumer’s dollars.

Rates are higher than they were prior to March 2022 and in a couple of months, they will probably be higher still. The economy is still flexing with increased wages and since we are likely going to see rates rising for the foreseeable future, it is a good time to purchase business equipment.

Given the Fed’s plan to increase the federal funds rate, it may be wise to refinance any variable-rate business loans. Traditional banks may be tightening on borrowers, but Commercial Capital Company is still putting small business owners first. Businesses will need to be agile to take advantage of the recovery. Acquiring the equipment necessary to compete in the opportunities of economic recovery is a primary focus for companies seeking growth.

The real value of your equipment comes from operation, not from ownership. Leasing guards your cash flow by offering monthly payments that are easier to manage than bank loans.

With a lease, you can deduct your entire lease payment as an expense, which will allow you to write off expenses quicker. Don’t forget the tax benefits of Section 179. The amount you save in taxes may in fact exceed the lease payments which makes Section 179 very attractive to the bottom line. Purchase your equipment prior to December, 31, 2022 and reap the deductions in 2023.

It’s important to mitigate the risks while also reaping the rewards as the economy recovers. At Commercial Capital Company, we have been able to turn uncertainty into opportunity by listening to our clients and providing them with financing solutions that help their small businesses grow.

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