On June 15, 2022, the Federal Reserve raised interest rates by 0.75 percentage points, the highest increase since 1994 and the third rate hike this year. The federal funds rate is vital in the Federal Reserve's monetary policy arsenal.
Effectively, it regulates the cost of money in the US economy and determines the overnight lending rate between banks and other depositories. Consumers may wonder how this impacts them. Yet to fully grasp the federal trade, it is necessary to understand why the Fed raised interest rates.
CFP® Matt Gray, the owner of AnthroFi Wealth Group, explains the Fed's rationale. He states, “With many participants in an economy, spending a lot of money, raising interest rates and slowing down consumption, is a strategy by the Feds to fight inflation.”
The second reason, according to Gray, is the inverse of the first. He explains that sometimes the Fed may lower the Fed Funds Rate to encourage spending and boost economic activity when the economy is performing poorly.
However, “the Fed didn't have much room to lower rates before the most recent increase, and this is what economists refer to when they say something like “didn't have arrows in the quiver” or “reloading for the next recession,” Gray says.
According to Gray, the Fed Funds Rates have the most significant effects on banks and lending organizations. As a result, these effects are passed onto consumers through interest rates on savings accounts, personal loans, and mortgages.
Homebuyers May Pay More
Mortgage rates have been growing fast before the Fed hike, so consumers can expect lenders to continue to raise rates to make a profit. For instance, Dovid Price, Wealth Advisor at Glass Jacobson Financial Group, illustrates that a 30-year mortgage payment at 3% is $1,264 and rises to $1,798 when the rate doubles to 6%, or a 42% increase.
Not only does this increase the final cost to the borrower, but it also makes it more challenging to be approved for a similar loan. In addition, because banks will only allow your monthly payment to be a certain percentage of your income, Dovid says.
But there's also some good news, according to Robert Johnson, Professor of Finance at Heider College of Business, who serves as CEO and Chair of Economic Index Associates. He predicts that home prices will likely level off (or even fall) from the highly speculative prices we have recently witnessed. The price stabilization will result from a slow down in the housing market that has been red hot in recent months, he explains.
Borrowing Becomes Expensive
Justin Hoogendoorn, head of fixed income strategy and analytics at Hilltops Securities, says, “For specific borrowers, the Fed's impact is driven primarily by the length of the borrowing term and how much the Fed wants to encourage lending.”
He explains further that when the Fed raises rates, they tend to directly increase the cost of shorter-term loans, such as credit card and auto loan rates. According to Hoogendoorn, the Fed's ultimate goal is to lower long-term rates by combating inflation as it raises short-term rates.
Consequently, the hike has a cumulative effect on credit cards. Price puts it in perspective again. He illustrates that if you have a credit card debt of $10,000 and are committed to paying it off within 5 years, at 9% interest, you would need to pay $207.59 monthly. But at 12%, you would need to pay $222.48 or 9% monthly.
Savings May Yield Better Interest
“Due to the Fed's increase, the returns on savings accounts and other fixed-income investments (such as certificates of deposit, money market accounts, etc.) will rise,” according to Robert Johnson, Ph.D.CEO and Chair at Economic Index Associates. However, Johnson warns that savings rates typically don't increase as quickly as home and car loan rates.
Additionally, there lies the difficulty of saving money in an inflated economy to benefit from high returns.” In a vacuum,” Gray says, “a higher Fed Funds Rate promotes saving because the yield or return of an interest-bearing investment is higher.”
Sadly, Gray acknowledges that the current inflation rates make it challenging to make ends meet, so saving has taken a back seat. While the Fed is working to strike a balance between encouraging savings and consumption, it's certainly not an easy balance to find, notes Gray.
Even though the Federal Reserve is trying to thread the economic needle and realize a soft landing, analysts predict a recession is just around the corner. In addition, increased geopolitical concerns outside the Fed's monetary policy levers have fueled fears of stagflation, which combines slow growth and low monetary value.
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This post was produced and syndicated by Wealth of Geeks.
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Amaka Chukwuma is a freelance content writer with a BA in linguistics. As a result of her insatiable curiosity, she writes in various B2C and B2B niches. Her favorite subject matter, however, is in the financial, health, and technological niches. She has contributed to publications like ButtonwoodTree and FinanceBuzz in the past. In addition to ghostwriting for brands like Welovenocode, Noah and Zoey, and Ohcleo, amongst others. You can connect with her on Linkedin and Twitter.