By now, you know that the U.S. Federal Reserve Board raised the so-called Fed Funds rate by three quarters of a percent—the largest increase since 1994. You may also have heard that the size of the increase took everybody by surprise—a list that includes economists, pundits, journalists and professional investors. The news drove the markets, already teetering on the edge, into bear market territory—defined as a 20% drop from previous highs.
The stated reason for the rate increase is to squeeze inflation out of the economy. The logic is somewhat complicated, but the simple explanation is that inflation occurs when too much money chases too few goods. Raising rates will make it more expensive to borrow, diminishing purchasing power on credit, which could (eventually) result in less borrowing, which could (eventually) slow down consumer spending.
Here are a few ways that this could impact you:
- Borrowers: Borrowing costs will continue to increase. That means it will cost more for home equity lines of credit, credit cards, student loans, car loans, and mortgages. The Fed’s previous rate hikes this year have already hit prospective homeowners hard. The rate for a 30-year fixed-rate mortgage averaged 5.23% in the week ending June 9 — up from under 3% this time a year ago. Business loans will also get more expensive for companies large and small.
- Investors: The Fed raises interest rates in order to slow down the economy and control inflation. Markets don’t like when the economy slows down, and investors tend to respond by doing more selling than buying – thus the lower values on your investment statements. The Fed’s objective is to strike a balance between effective control of inflation, and not slowing the economy too much. It’s not easy to achieve and a lot of influential people tend to second guess the FedDuring this time, it is important for investors to keep the long-term in mind and avoid emotional decisions.to avoid poor financial outcomes.
- Savers: The “sliver of a silver lining” will be for savers with cash in savings accounts, money market accounts, or CDs. Having earned almost nothing for years, cash savers may finally see a little interest hit their accounts once again. It’s important to note that even after several rate hikes, savings rates will still be meager — below inflation and the expected stock market returns.
If you look at the bigger picture, the American economy has experienced something quite extraordinary: more than four decades of falling interest rates, until they finally fell down to zero (short term) or near zero (longer-term) and had no more room to fall. The Fed action has built on a reversal of that trend, sending mortgage rates to their highest level in nearly 14 years.
You might wonder whether curbing inflation is worth the collateral damage of negative economic growth, diminished consumer spending and reeling investment markets where confidence in the future is shaken. The Federal Reserve’s answer is likely to be that sooner or later they had to take away the punch bowl that led to the economic equivalent of drunken excesses. They might have been more gentle about it, but we all know that economic booms eventually lead to busts, which ultimately deliver a healthier economy and, for investors, provide opportunities to buy stocks at a discount.
The Fed has challenged all of us, whether we run companies or manage our monthly budgets, to endure a painful transition that was probably inevitable, and take our medicine all at once rather than gradually over a longer period of time. Yes, the medicine tastes terrible right now. Let’s hope it provides the cure that the U.S. central bank is hoping for, and that this will lead us into the next economic expansion and a new bull market.
Remember, there are financial opportunities in all market cycles. We specialize in identifying them for you and encouraging actions which can benefit you financially – during all market and economic cycles.
Don’t hesitate to get in touch with us if you have questions or concerns as we navigate this period of economic history together.