The Fed Just Increased Interest Rates — Here's How It Will Affect You
Wednesday afternoon The Federal Reserve voted to raise the federal funds rate for the fourth time since 2008, from 1% to 1.25%, and is expected to raise rates once more this year. So how will the affect you and the economy in general? Here's what you need to know.
The Fed Increased The Federal Funds Rate, Which Is What Banks Charge Each Other For Loans
While the interest rate that was raised is not one that consumers directly interact with, the rise is expected to affect other interest rates indirectly as banks and other institutions compensate for the hike.
[The raise] is likely to have a domino effect across the economy as it gradually pushes up rates for everything from mortgages and credit card rates to small business loans. Consumers with credit card debt, adjustable-rate mortgages and home equity lines of credit are the most likely to be affected by a rate hike, says Greg McBride, chief analyst at Bankrate.com.
Credit Card Customers Will Feel The Increase First
Credit card users will feel an immediate effect because the prime rate1 is directly tied (3 percentage points above) to the federal funds rate.
[B]ecause credit card debt is so much more expensive than other forms of credit… an already expensive way to borrow will become even more burdensome…. Experts always advise paying monthly balances in full, but roughly 40 percent of consumers don't do that. And among this group, the typical balance stands at nearly $17,000. The extra quarter-point's impact is small for now, equaling about $42 per year on that typical balance.But if the Fed moves two more times this year, that will add another $85 annually for the typical family that carries a balance on its cards.
Mortgages Aren't Expected To Be Affected
According to Nariman Behravesh, chief economist at IHS Markit, mortgage rates shouldn't be affected.
Long-term mortgages tend to track the rate on the 10-year Treasury, which, in turn, is influenced by a variety of factors. These include investors' expectations for future inflation and global demand for U.S. Treasurys…Since the presidential election… the 10-year yield has risen in anticipation that tax cuts, deregulation and increased spending on infrastructure will accelerate the economy and fan inflation.
History Says The Hike Will Hurt The Stock Market
Historically, higher interest rates are followed by a tumble in the stock market due to the fact that consumers may spend less if borrowing costs more. Nautilus Investment Research's Tom Leveroni and Shourui Tian explained the idea to Business Insider:
The S&P 500 has endured significantly below average results from 1 to 12 months after 3rd rate hikes in 11 events back to 1955…Six (more than half) of those hikes occurred within a year of a major cyclical top for stocks (1955, 1965, 1968, 1973, 1980, 1999).
But The Markets Initial Reaction Has Been Neutral
Reaction was muted on financial markets to the Federal Reserve's latest rate increase, which was widely expected by investors.
Bond yields didn't move much after the Fed's announcement at 2 p.m. The yield on the 10-year Treasury note was 2.12 percent, the same as shortly before the statement came out. That rate is closely tied to interest rates on mortgages and other kinds of loans.
The Standard & Poor's 500 index, the benchmark that professional investors follow, likewise wasn't changed much either. It was down a point to 2,439.
The Dow Jones industrial average was up 22 points, or 0.1 percent, to 21,352, little changed from before the announcement.
The Hike Is A Sign Of Confidence In The Growth Of The US Economy
After the financial collapse, The Fed reduced the interest rate to 0% to encourage borrowing and growth. Now, the economy has been consistently growing for years.
A rate hike is a sign that the Fed is confident about the pace of growth in the U.S. economy. The Fed placed its key interest rate at 0% in December 2008 to resuscitate the collapsed housing market. But a little over eight years later, the U.S. economy is in much better shape and has grown, albeit slowly, since late 2009.
The Fed Is Trying To Stabilize Inflation
After a period of trying to stimulate inflation to help keep the economy growing, The Fed has determined that the inflation rate in the US is approaching its optimal level. By making it harder to borrow money, The Fed is controlling the level of demand, which will control inflation.
The Fed also highlighted a recent increase in inflation after a long period of sluggishness. Prices are now rising at roughly the 2 percent annual pace that the Fed regards as optimal. The Fed, which had made faster inflation a central objective, said on Wednesday that it was now focused on stabilizing inflation.
Overall, higher interest rates mean that the economy is on the right track, according to the fed, but consumers may feel the effects when they go to pay their bills.
