Since the start of the year, Americans have been paying more to secure mortgages and auto loans, as well as to pay down their credit card debts.
And as higher prices are also burning a larger hole in consumers’ wallets, it may seem counterintuitive that the Federal Reserve is expected to make borrowing costs even higher by raising rates on Wednesday.
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But the reason stems from the fact that even though rates are higher than they were for much of the first two decades of the 2000s, consumer spending, business investment and other measures of the health of the economy are all running hot. And inflation, the rise in prices that can result from such vigorous spending, has hovered above the Fed’s 2 percent target rate for half a decade.
“Raising interest rates is specifically intended to deter spending,” said Thierry Wizman, a strategist on global fixed income and rates at investment bank Macquarie Group. “So the pain that the consumer is feeling if they’re obligated to pay more on a home, or a car loan, or on a student loan, is intentional.”
In 2022, before the Fed began a period of inflation-induced increases, interest rates hovered around zero. They rose to between 5.25 percent and 5.5 percent in 2023. Today, they sit between 3.5 percent and 3.75 percent.
These rates determine short-term borrowing costs. When they go up, lending conditions for banks tighten, creating a domino effect that can reduce consumer spending and business investment. But so far, higher rates have not done much to slow the economy.
Americans spent $36 billion more in the U.S. economy in July compared with the month before, according to the latest personal expenditures report from the Bureau of Economic Analysis. The boost in spending was driven by a robust labor market that has pumped up wages and Americans’ disposable income.
For a while, this spending has been uneven across income brackets in the United States. This is what has been described as the “K-shaped” economy, with the less wealthy represented by the lower-trending line and the wealthy the upward-trending line.
“Not everyone owns a home and not everyone owns equities — but it’s that part of the economy, the consumer, that’s been driving growth, the upper part of that ‘K,’” said Leslie Falconio, head of fixed income strategy for UBS Global Wealth Management.
Consumers converge
Still, there are signs of convergence in that lopsided picture, according to analysts who examined credit card spending data from Bank of America. Spending by lower income consumers has risen disproportionately in recent months, they said.
Business investment is also booming, propelled by investors’ betting that returns from artificial intelligence will outpace the cost of borrowing. The stock market is reflecting confidence in tech as well, bolstered by a blockbuster earnings season. The S&P 500 is up roughly 11 percent since the start of the year.
Part of the Fed’s mandate is to maintain stable prices. Inflation is still ringing in at more than 2 percent year-over-year — where the Fed would like it — with the numbers for August coming in hotter than expected. A big driver of inflation has been an energy crunch set off by the disruption of global oil flows in the Middle East. The global price of oil has risen 15 percent this month alone.
Perhaps the only sector that has relented in the face of higher rates is the housing market. Home sales are falling as mortgage rates have crossed 6.7 percent for the first time since July 2025. But many homeowners able to lock in mortgages at lower rates secured years ago have been able to reduce the strain on their wallets.
“That resiliency and that growth outlook that continues to be strong allows the Fed to say, ‘OK, I’m going to continue to focus on this price-stability side, because the interest rates aren’t restrictive and we can hike — growth isn’t teetering,’” Ms. Falconio said.
Watching yields
The Fed’s policy path most directly affects interest rates, or yields, on shorter-term U.S. Treasuries, like the two-year note. Longer-term yields move based on Fed policy but give more weight to factors like inflation and the national deficit.
The two-year bill has ticked up to 4.66 percent for the first time since 2024. The 10-year note, which sets the pace for most consumer loans, has punched past 5 percent this week, the highest level since 2023.
Markets have priced in a rate increase at the Fed’s meeting on Wednesday so a hike this week would help those yields ease lower, Ms. Falconio said.
It would signal to investors that the board is proactive about managing inflation, coaxing them to expect inflation to moderate and demand a lower return on long-term government bonds, she said.
That easing would take time to translate into lower rates for consumers.
“If growth stays resilient, and they hike five or six times, then the long end is not going to go down,” Ms. Falconio said about long-term bonds. “It really depends on how many times they hike.”
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