The Federal Reserve in mid-March announced that, for the first time in three years, it would raise interest rates by a quarter of a percentage point (0.25%). While this was an expected move, it will still cause some changes in the financial landscape as we know it.
To understand how rising interest rates can affect you personally, you first need to understand what we mean when we talk about federal interest rates.
What do we understand by interest rates?
When we talk about the Federal Reserve, we mean the federal government, specifically the Federal Reserve in this case. When you hear the phrase “The Federal Reserve is raising rates,” what it really means is that the Federal Reserve is changing its target for the fed funds rate, which is the suggested rate used by the FOMC (Federal Open Market Committee). . This rate, set by the FOMC, determines what commercial banks must charge when they lend money to other banks. Banks then take their excess reserves and hold a percentage of them to cover deposits and lend the excess to each other in what is known as the night market. This is not a mandate that banks do it, or a mandate of the exact rate they can charge, it’s just a suggestion, and what follows is a negotiation, but most banks follow these guidelines set out by the FOMC and federal funds. Velocity.
What affects the rate?
The fed funds rate affects inflation. The federal government is mandated to keep inflation within the range of 2% to 3%, or what they call stable prices. The government believes that 2% to 3% inflation is a healthy and constant amount of inflation, and when inflation is higher or lower than this amount, the federal government can use accommodative or restrictive monetary policies to bring inflation back. to be within target range. Adjusting the fed funds rate is often your first option to manipulate the rate of inflation.
Lowering the fed funds rate is a tool the government has used when inflation is low and the economy needs a boost. We have seen them use this to boost the economy during recessions and during the start of the pandemic. In March, inflation reached 8.4%, more than double the target range. Therefore, the federal government is moving to increase interest rates, which is a restrictive monetary policy to slow down the circulation of money within the economy. With less money in circulation, it will discourage a sharp rise in prices.
How does the rate hike affect you?
This increase in interest rates is somewhat expected, and we also expect the Federal Reserve to continue raising interest rates for the remaining six meetings this year. While the current increase is 0.25%, with the increases added we may be looking at a 2% increase by the end of the year.
This will affect your finances if you have anything on a variable rate vehicle, such as credit cards and variable rate loans, including car loans and adjustable rate mortgages. If you can lock in a long-term rate, you may want to do it now, while rates are (relatively) lower, rather than later, as they can add to your time.
Other possible effects of higher interest rates:
- We could expect to see house prices cool off.
- Bond yields are likely to rise and bond prices are likely to fall.
- In general, anything financial that is tied to an interest rate will be decently higher at the end of the year.
- Your savings account rates should also increase during this time period, so you can earn more interest on your savings account, especially if you switch to an online-only bank with a higher interest rate.
Much of the market reaction we have seen this part of the year, outside of the Ukraine invasion, involved revising interest rate expectations. The Fed has indicated that more rate hikes are on the way, so we can anticipate additional volatility. Investors should remember that the market has its ups and downs and that investing is a long-term strategy. This is where a financial advisor can help, because he or she can help investors counteract their own behavioral biases and avoid making rash decisions.
Working with a financial planner is always a good idea, as they can help you plan for what’s coming next in the markets, regardless of rising or falling interest rates.
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President, Partner and Financial Advisor, Diversified, LLC
In March 2010, Andrew Rosen joined Diversified, bringing with him nine years of experience in the financial industry. As a financial planner, Andrew builds lifelong relationships with clients, providing guidance through all stages of life. He has earned his Series 6, 7 and 63, along with property/casualty and health/life insurance licenses.