With the US Federal Reserve’s announcement Wednesday to hold interest rates steady at a target benchmark of 5.25-5.50%, broad implications of this decision are starting to line up across the financial services arena.

Continuing at the highest level since 2001, current rates are being held in place by the central bank board because of what they call “a lack of further progress” in bringing down their other, key target rate: inflation. No reduction in interest rates could generally be seen as a positive development for banks and credit union profitability, but a slowing economy due to persistently high inflation could spell a completely different set of problems for financial institutions.

What’s up with inflation?

Labour costs grew substantially over the last quarter, while some other expenses moderated, especially prices for certain grocery store items previously hit by widespread supply chain shortages. In fact, in a sign that high prices hadn’t been quite as damaging as expected, the Fed’s Chairman Jerome Powell noted that “robust” consumer spending had persisted over the last several quarters of 2023 and the first several months of 2024.

In the central bank’s words: “Improving supply conditions have supported resilient demand and the strong performance of the U.S. economy over the past year.”

However, other items purchased by the typical household, including car insurance and gas at the pump to fuel automobiles and other vehicles, have both increased in the past month or two heading into what’s long been predicted to be a busy summer.

Gas prices in particular will weigh particularly heavy into creating higher costs over the short term for just about everything that needs transport to local stores or consumers’ homes, so regardless of their true cause (speculation over impacts of current Middle East tensions, spring changeovers of gas formulations by US refineries, desire to increase profits by oil companies, or all of the above), fuel price rises mean inflation won’t likely be falling back to the Fed’s optimum annual rate of 2% anytime soon.

Some pundits speculate it could instead be jumping up again into the 4% range over the next few months, pending changes in the other main contributors to the cost-of-living indexes used in the inflation rate’s official calculations and reporting.

What will be the impact of influential macro forces in the economy on financial institutions?

For financial institutions the impact will not be too painful at this time, except to the extent their own costs increase, or that consumer demand and discretionary buying in general might become more subdued than they have for most of 2024 and really since the world emerged from the pandemic.

Banks have an opportunity to preserve profit related to the spread between what they pay on deposits and what they charge for loans, lines of credit, and balances on credit cards. Those spreads (pandemic emergency excepted) are near their healthiest levels over those same 23 years as current Fed target rates are also at their highest.

Banks are in most cases reporting healthy returns lately, and this is enhanced if a particular financial institution has a robust loan portfolio with credit lines being drawn upon steadily by consumer or business customers, or if they’re seeing healthy credit card spending by card holders – which means higher interchange revenue from in-person and ecommerce transactions.

What can consumers do about employment prospects?

However, consumer behaviour can’t help but be impacted by what was also reported today: extremely low figures for new job openings. According to the US Labor Department’s Job Openings and Labor Turnover Survey (JOLTS), the hiring rate across all industries is at its lowest point since the inception of the pandemic in 2020. There were just under 8.5 million job openings at the end of March, the lowest since early 2021, down 1.1 million over the year, and down from 8.8 million a month earlier. Layoffs in many prominent industries continue to make the news every day: the latest being the thousands of line workers and senior executives cut loose by Tesla in the past day to two weeks.

Some call these trends “normalisation” of a previously overheated job market – especially in the tech sector, which has since 2023 responded with waves of substantial employee layoffs. Others would call them distressing signs of a coming slowdown, maybe not for corporate profits with all the cost-cutting typically targeted at employee costs first, but definitely for consumer spending and attitudes about making large investments if enough people don’t have confidence about their employment prospects.

U.S. mortgage rates remain near their highest levels in more than 20 years as well. Couple high home financing hurdles with extraordinarily expensive housing prices in many key markets, there’s no easy relief in sight for those wanting a new back yard or deck to enjoy – at a fair price or carrying cost – for this summer. But at least they can earn 5% or more on that high-interest savings account now offered by many institutions across the country!

Indeed, maybe it won’t be rosy for banks and credit unions much longer. Despite their healthy margins on loans vs. deposit rates, there may not be enough spending and demand for purchases spread throughout the economy from cautious consumers and cash-conserving businesses to ensure that their chosen financial institutions can keep reporting increasing profits in coming quarters.

What is the state of the economy during the campaigns?

The economy is always a major issue in any campaign season, and higher interest rates and stubborn inflation will surely impact voter decisions in US (and global) elections coming later this year - if the trends don’t change.

As for those trends, the ‘street’ bets by policy experts on when the Fed will finally lower its target rate benchmarks have now slid all the way to September, with the Fed Open Market Committee confab that month scheduled the 17th. That’s only seven weeks before a closely watched and hotly contested presidential and congressional election on November 5th.  

Only a couple of months ago, prognosticators were calling for rate cuts in June, and in fact multiple decreases were predicted to follow all summer as the Fed signalled inflation was back under control. This doesn’t appear at all likely now.

So, what’s a bank customer (or employee) to do? Maybe it is time to take that vacation somewhere else than home – and as of now, predictions of a very busy summer of holiday travel have not changed. Just make sure to bring extra cash along (or a healthy balance available on your credit or debit card.) Unfortunately for spenders, it’s unlikely that airline tickets, fuel prices, hotel rates, costs for cold drinks, umbrellas for those drinks, or tabs for relaxing meals or adventurous excursions are going anywhere but up for anyone anytime soon.