The Federal Reserve elected to raise interest rates for the first time in three years in a unanimous decision Wednesday.
As a result, the Federal Reserve Open Market Committee (FOMC) raised the target range for the federal funds rate by a quarter percentage point to 3.75% to 4%.
“There is an ongoing debate about whether higher interest rates are the right tool when some of today’s inflationary pressures stem from supply-side shocks, including disruptions involving Iran and the Strait of Hormuz,” notes Zonda chief economist Ali Wolf. “The Fed, though, appears more concerned about the risk of inflation reaccelerating and would rather act proactively than risk falling behind the curve.”
In its statement announcing the decision, the FOMC noted economic activity is expanding at a “solid pace” while uncertainty remains elevated due to geopolitical developments. However, the committee noted domestic spending has remained resilient, productivity growth has been strong, and capital investment “is robust.”
Despite a stable employment market and an unemployment rate that has changed little, inflation has remained elevated above the Fed’s long-term target of 2%. Data from the U.S. Bureau of Labor Statistics (BLS) indicated inflation increased 0.4% on a monthly basis in August while the annual inflation rate remained at 3.4%. Rising energy costs, which rose 2.1% in August alone, are a major component to the persistently elevated inflation levels facing consumers.
The FOMC said its decision to raise the target range for the federal funds rate should “support a timelier return” to its 2% target.
Wolf says that while data suggests income levels have risen to record levels, many consumers continue to feel financially stretched in the current market.
“The disconnect comes down in large part to inflation and the rising cost of living, both of which have eroded purchasing power,” Wolf adds. “Consumer inflation expectations also suggest that inflation could remain elevated for longer than many had hoped.”
Officials also released updated projections for 2026. Following June’s meeting, when half of the FOMC projected just one rate increase during the year and half expected rates would remain steady, the majority anticipate at least two rate cuts for 2026.
For the housing market, the Fed’s announcement is not likely to calm the affordability and consumer confidence headwinds working against builders. Mortgage rates remain above 7% and consumer sentiment remains near record low levels. At the same time, builder sentiment has remained pessimistic throughout the year.
“While the Fed does not directly set mortgage rates, consumers will likely see headlines about the rate hike and assume borrowing costs are moving higher,” Wolf says. “In reality, mortgage rates had already priced in much of the expected hike ahead of the Fed’s announcement.”
