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If you’ve ever wondered what the Federal Reserve has to do with your finances, look no further than your next credit card bill.
Americans recently crossed the $1 trillion mark in credit card debt outstanding, according to the Federal Reserve Bank of New York. That means interest rate decisions by the Fed have never had a greater impact on household budgets.
This takes on even greater significance because the Fed has raised interest rates by 5.25% in the past year and a half. As a result, that record amount of credit card debt has gotten considerably more expensive.
Indications are that the Fed may push credit card rates higher still. Consumers need to be aware of this, and plan accordingly.
Reading the Fed’s signals
There’s a lot of speculation about what the Fed will do next. The best clues come straight from the Fed itself.
A committee of the Federal Reserve, the Federal Open Market Committee (FOMC), has eight scheduled meetings a year at which it makes interest rate decisions.
In between those meetings, the FOMC tries to make its announcements less disruptive to the financial markets and the economy by sharing information on where it thinks its monetary policy is leading.
One type of signal the Fed provides is a regular set of economic projections. Four times a year, the FOMC provides a forecast of what it expects key economic indicators to do over the next few years. One of these indicators is the Fed funds rate, which is the key interest rate that the FOMC sets.
The FOMC made its most recent economic projections in June. These indicated that the Fed funds rate would be at 5.6% by the end of this year. Since that’s about a quarter point above where that rate is now, this means the FOMC expects one more rate increase between now and year end.
Besides those economic projections, members of the FOMC periodically share their thinking in public comments. For example, Fed Chair Jerome Powell made a speech reiterating the Fed’s commitment to bringing inflation down to a target of 2%. While they have made progress towards that goal over the past year, some measures of inflation remain twice as high as that target.
In his comments, Powell made his thinking on this clear: “We are prepared to raise rates further if appropriate.” He added that “there is substantial further ground to cover to get back to price stability.”
Economic conditions will dictate the Fed’s next moves
The Fed is raising rates in an attempt to cool off inflation. It will only back off from that course if it is satisfied that inflation is under control or if it becomes concerned that slowing the economy too drastically will cause a spike in unemployment.
The latest economic developments show no sign of altering the Fed’s path towards higher rates:
- While it was once widely believed the economy was heading for a recession this year, growth actually strengthened in the second quarter of 2023.
- A tight labor market, with unemployment near a 50-year low, is fueling inflation by putting pressure on wages.
- The easing of inflation since the middle of 2022 was helped greatly by a decline in oil prices. However, those prices have surged since mid-June as oil producing nations have lowered their production targets in an attempt to boost prices.
- Low water levels in the Panama Canal recently have limited traffic through that key shipping lane. This could disrupt supply chains that have only recently gotten back to normal after COVID. The resulting shortages could cause prices for some products to jump.
These conditions add to the belief that the Fed may not be done raising rates.
The Fed isn’t the only thing driving credit card rates higher
The Fed has a huge impact on credit card rates. Many credit cards link their rates directly to the Fed funds rate, so that when the Fed raises rates the rates on those credit cards go up automatically.
However, the Fed isn’t the only thing driving credit card rates higher. The average rate charged on credit card balances started rising in the second quarter of 2021 – nearly a year before the Fed funds rate started rising. In all, credit card rates have risen by 6.25% since then – a full percentage point more than the total increase in the Fed funds rate.
One additional factor may be default risk. When more credit card customers fail to pay their bills, credit card companies often raise their rates to protect against this risk.
Credit card default rates have been rising since since late 2021. This may be helping to push credit card rates higher – especially for customers with lower credit scores.
Recent changes make this a key time to re-check your credit cards
Between rapid Fed funds rate increases and rising consumer defaults, the past couple years have seen a whirlwind of changes affecting credit card rates.
Different credit card companies react to changes like these at different times and to different degrees. That makes this an ideal time to take a fresh look at your credit cards.
Because so much has changed, the credit card that offered the best deal a couple years ago may no longer have the most competitive rate. Check the latest rates on your current credit cards, and also shop around a little to make sure you are still getting the lowest rate possible.
Don’t wait – steps you can take to pay less credit card interest now
Between the Fed’s battle with inflation and rising consumer defaults, credit card rates may not be coming down any time soon. They may even be headed higher.
However, there are a number of steps you can take right away to limit the amount of credit card interest you pay:
- Reduce your debt balance. With credit card rates so high this is a bad time to be carrying large balances on your cards.
- Refinance. If you can’t pay down your balances right away, you can at least look for ways to reduce what you’re paying on those balances. Balance transfer credit cards or personal loans may allow you to refinance your credit card debt at a much lower rate.
- Shop around. As noted earlier in this article, the fast-changing rate environment of the past couple years makes this a key time to take a fresh look at what rates are available.
- Work on your credit score. If default rates keep rising, the spread between rates people with good credit and those with poor credit pay are likely to widen. Improving your credit score can help shield you from this added cost.
Credit card debt has become more expensive than ever. Take steps to fight back by reducing the impact of rising interest rates on your card balances.