Americans Aren't Ready for an Interest Rate Hike—And Neither Is the Fed

0917_interest rate hike fed
A woman walks past the Federal Reserve headquarters in Washington Wednesday. The Fed will face this week its biggest policy decision yet under Chair Janet Yellen as it decides whether to wait or raises interest rates for the first time in nearly a decade. Kevin Lamarque/Reuters

Updated | In case you hadn't noticed, interest rates have been at near-zero since the end of 2008, when the entire U.S. economy was facing disaster. This has meant money is cheaper to borrow and it's given the stock market back its zing.

It has also ushered in some perverse side effects. So hooked are investors on easy money that bad news for the markets is now perceived as good news for them, because it keeps the cheap cash flowing.

Cheap money is a good thing when the economy is struggling to recover. But too much cheap money and the economy can overheat, leading to inflation, bubbles and runaway prices.

That's why it's so important for the U.S. Federal Reserve to proceed carefully on exactly when it pulls the rate-hike trigger, which is why its policy-making committee decided not to raise rates when it wrapped up is two-day meeting Thursday. In a statement, the central bank noted that "economic activity is expanding at a moderate pace," but added that it would keep federal fund rates unchanged and within a target range of between zero and 0.25 percent for now.

At a press conference immediately following the meeting, Fed chairman Janet Yellen emphasized that while the nation's "recovery from the Great Recession has advanced sufficiently far" to justify discussions of a rate hike, committee members decided not to raise rates in light of low energy prices and a strong dollar putting a "drag" on inflation.

The "outlook abroad has appeared to become more uncertain of late," she added, amid a China-driven slowdown, plus the Fed wanted to see more progress in the labor market.

For most of the summer, Americans had been bracing for the Fed's first interest-rate hike in more than nine years—and, until recently, there were strong hints that decision would arrive this month or, at the latest, before the end of the year.

At the press conference Thursday, Yellen emphasized that while inflation remained well below the Fed's medium-term objective of 2 percent, the drag on the U.S. economy is expected to be "transitory" and the "great majority" of Fed committee members are expecting to vote to hike rates this year—perhaps as early as October.

Only four committee members are projecting a rate hike will be delayed to 2016, she said.

While this afternoon's announcement was breathlessly billed as Yellen's "cliffhanger" moment, the verdict was already in from everyday Americans: the economic recovery may be well under way for those who already have plenty of cash in their pockets, but the rest of the country simply needs more time to recoup.

While the stock market is up more than 250 percent since hitting its trough during the Great Recession of 2008-2009, this has not led to an increase in the average American's paycheck or overall wealth level, which remains effectively wiped out.

Annual data released this week by the U.S. Census Bureau show that even as the nation's unemployment rate dropped to 5.1 percent in August and the economy posted gains, the median income for middle-class households is unchanged in the fifth year of the economic recovery.

Although Yellen stated that no single data point would determine the timing of a rate hike by the Fed, she repeatedly highlighted the labor market as a critical area for improvement, noting that the labor participation rate is below-trend. In July, the number of Americans over the age of 16 participating in the labor market came in at 62.6 percent—the lowest level on record since 1977 and seen as reflecting the number of Americans who have simply stopped looking for work in a tight market.

The Fed in 2012 agreed to keep interest rates near zero until the unemployment rate fell below 6.5 percent. That gives it a clear path to raising rates now. But the estimated 1.7 million new jobs created so far in 2015 are dwarfed by the number of new university graduates who entered the job market this spring—around 2.8 million.

Meanwhile, 14.8 percent of Americans continue to live below the federal poverty line—well above the pre-recession level of 12.5 percent seen in 2007, according to the latest annual data from the Census Bureau. That's 47 million people who are still feeling zero effects of the recovery.

Consumer confidence took a hit in September after a brief respite, falling to its low for the year, according to a preliminary report from the University of Michigan. And while energy prices are low, the declines "have not yet increased consumer optimism about the economy," according to a September survey released this week from the National Association of Convenience Stores, an industry group based in Alexandria, Virginia. "Less than half of all consumers are optimistic about the economy," it said.

One of the biggest steps to attaining wealth for ordinary Americans is buying a home—a process that has been made somewhat easier in this era of near-zero rates. This summer, Americans raced to buy and refinance their homes, with new mortgage applications climbing more than 20 percent from June to mid-August, says Joel Kan, associate vice president of industry surveys and forecasting for the Mortgage Bankers Association, a Washington industry group. This, certainly, is allowing some Americans to regain a bit of financial footing.

"If you compare this increase to what we saw last year, this has been a better year relative to 2014, when mortgage applications were essentially flat," Kan tells Newsweek.

The traditionally high-traffic summer buying season hasn't yielded such strong gains since 2011, according to the MBA's Market Composite Index, which measures the rate of all new mortgage applications. About half are to refinance homes. And in a sign consumers are acting to take advantage, Kan says about 85 percent of borrowers with a 30-year fixed mortgage are borrowing at a rate less than or equal to 4.5 percent. That's a good sign for their long-term wealth prospects, even if it's not showing now.

But even with the summer surge, since mid-August there's been a marked pullback from those in the market looking for a home or filing to refinance. Ahead of the Fed's decision, total mortgage applications fell by more than 13 percent for the two weeks ending September 11.

Last week's drop of 7 percent alone was the biggest in more than three months—although Kan notes it was likely affected by the Labor Day holiday. The biggest one-week drop in 2015 was just over 13 percent in mid-February.

All of which sends another signal that America's recovery may still be dependent on rates staying low.

How the central bank proceeds in the coming weeks will be very instructive in revealing how much it weighs the plight of ordinary Americans against the resurgence of Wall Street. Yellen says the Fed expects to see unemployment decline to its lowest sustainable level sometime in 2016 before "leveling out," according to committee members' median estimates, while inflation isn't expected to reach the Fed's 2 percent objective until 2018.

As Republican presidential contender Jeb Bush emphasized during the GOP debate last night, much more hangs in the balance than markets and mortgages. He went so far as to link American prosperity with its fate as a superpower, stating, "Without a high-growth strategy, our country will never have the resources or the optimism to lead the world."

This story has been updated after the Fed's decision to hold rates unchanged with comments from Janet Yellen explaining the decision.

Americans Aren't Ready for an Interest Rate Hike—And Neither Is the Fed | Opinion