Raising rates here: what does it mean for you?

Fed officials said Wednesday they are raising interest rates, beginning their first rate hike cycle since late 2015.

The fact that the Fed is finally moving away from zero is evidence of confidence in the health of the labor market. But the speed at which interest rates could rise highlights concerns about the skyrocketing cost of living.

Americans will experience this policy shift due to higher borrowing costs: it will no longer be insanely cheap to take out mortgages or car loans. And the money lying in bank accounts will finally bring at least some profit.

“Money will no longer be free,” said Joe Brusuelas, chief economist at RSM US.

When the pandemic hit, the Fed provided almost free loans to stimulate spending by households and businesses. To further stimulate the Covid-ravaged economy, the US central bank also printed trillions of dollars in a program known as quantitative easing. And when credit markets froze in March 2020, the Fed rolled out emergency credit lines to avoid financial collapse.

The Fed bailout worked. There was no Covid financial crisis. Vaccines and huge Congressional spending paved the way for a speedy recovery. But now the Fed must take on another challenge: rising inflation. Here’s how higher rates will affect consumers.

Loan prices are rising

Today, unemployment is very low, but inflation is very high. The US economy no longer needs all this help from the Fed.

Every time the Fed raises rates, borrowing becomes more expensive. This means higher interest rates on mortgages, lines of credit, credit cards, student debt and auto loans. Business loans will also become more expensive for large and small businesses.

This is most noticeable in mortgages, where expectations of higher rates have already led to higher rates.

Key inflation indicator hit double digits in February
The rate on 30-year fixed-rate mortgages averaged 3.85% in the week ending March 10. Although historically still cheap, it has risen sharply from less than 3% in November.
Higher mortgage rates will make it harder to access home prices, which have skyrocketed during Covid. But weaker demand could cool prices. The median price for an existing home sold in January rose 15.4% year on year to $350,300.

But it will still be relatively cheap to borrow

None of this means that financing purchases will suddenly become expensive.

Federal Reserve Chairman Jerome Powell said the central bank is likely to raise interest rates six more times this year to bring the average federal funds rate to 1.9% by the end of the year.

Even though it stands at 0.125% today, it is still historically low.

For context, the Fed raised rates to reaches 2.37% during the peak of the latest rate hike cycle at the end of 2018. Before the Great Recession of 2007–2009, Fed rates reached 5.25%.
And in the 1980s, the Fed, under Paul Volcker, raised interest rates to unprecedented levels to fight runaway inflation. By its peak in July 1981, the effective federal funds rate was over 22%. (The cost of borrowing will not approach these levels now, and it is unlikely that they will rise so sharply.)

However, the impact on borrowing costs in the coming months will depend mainly on the speed of the Fed’s rate hikes. There is still a lot of controversy about this, although chairman Jerome Powell said in January that he thought there was “a lot of room” for rate hikes without threatening the job market.

Good news for those who save

Extremely low rates penalized depositors.

Money tucked away in savings, certificates of deposit (CDs) and money market accounts has paid next to nothing during Covid (and, for that matter, for most of the last 14 years). Compared to inflation, savers lost money.

The good news, however, is that these interest rates will rise as the Fed moves away from zero. Depositors will start earning interest again.

But it takes time to play out. In many cases, especially when working with traditional accounts in large banks, the effect is not noticeable overnight.

And even after several rate hikes, savings rates will still be very low—below inflation and expected returns in the stock market.

Markets will have to adjust

The free money from the Fed was amazing for the stock market.

Zero interest rates lower government bond rates, effectively forcing investors to bet on risky assets like stocks. (Wall Street even has an expression for it: TINA, which means “no alternative”.)

The war brought the world to the brink of a food crisis
Higher rates could also be a problem for the stock market, which is accustomed to, if not addicted to, easy money. Markets have already experienced significant volatility amid worries about the Fed’s plan to fight inflation. The Nasdaq moved into a bear market last week, signaling a 20% decline from previous highs.
But much will depend about how fast the Fed raises interest rates – and how the underlying economy and corporate profits work after them.

At a minimum, the rate hike means the stock market will face increased competition from boring government bonds.

Cooler inflation?

The goal of the Fed’s interest rate hike is to bring inflation under control while preserving the labor market recovery.

Consumer prices rose 7.9% in February year-over-year, the fastest pace since January 1982. Inflation has not come close to the Fed’s 2% target and has worsened in recent months.

Economists warn that inflation could worsen further in March as commodity prices surged after Russia’s invasion of Ukraine. Everything from food and energy to metals has become more expensive, even though oil prices have pulled back from their recent highs.
And in recent days, China survived the worst outbreak of Covid-19 two years later, prompting the authorities blockade key parts of the country. The lockdown will increase pressure on the tangled supply chains that underpin inflation.

The high cost of living is causing financial headaches for millions of Americans and contributes greatly to a decade-long low in consumer sentiment, not to mention President Joe Biden’s low approval rating.

However, it will take time for the Fed’s interest rate hike to start reducing inflation. And even then, inflation will still depend on developments in Ukraine, the mess in the supply chain, and, of course, Covid.

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