The Fed Hiked Rates For The First Time Since 2018. Here’s What That Means For Your Wallet
On March 16, the Federal Reserve delivered on its longstanding promise to raise interest rates in order to fight rising inflation. The Fed has been under pressure to take measures to cool price surges that have taken inflation to its highest level in 40 years.
“We expect inflation to remain high through the middle of the year,” said Federal Reserve chair Jerome Powell at the post-Fed meeting press conference.
In a new forecast released with the rate decision, Fed economists estimated that inflation as measured by the PCE index should decline to 4.3% by the end of 2022. Compare that to the latest PCE reading, for the month of January, which measured prices up 6.1% over the prior 12 months.
Americans are anxious about the rapidly increasing costs of everyday items like groceries and gasoline, so it may seem counterintuitive to raise the cost of borrowing money when people’s finances are already strained.
However, higher interest rates—this decision is only the first of several projected rate hikes increases in 2022—should moderate demand for goods, which can in turn reduce inflation.
Why Is the Fed Raising Rates?
For months, Powell and other Fed officials have been repeating over and over that the four-decade highs in U.S. inflation rates were making tighter monetary policy an absolute necessity. It’s also become clear that the jobs market has almost entirely healed as the Covid-19 pandemic wanes.
Congress has bestowed two jobs on the Fed: Keep prices under control and promote full employment. It appears that the latter job is done, so the Fed is moving to tackle the former by tightening monetary policy.
At the March meeting, the central bank increased the federal funds rate—that’s what we mean when we talk about “raising interest rates”—by 25 basis points, to 0.25% to 0.50%. But this is only the first step in a longer journey: Analysts expect the Fed should deliver six more hikes in 2022, taking the fed funds rate to 1.9% by the end of the year.
Here’s the big challenge: The Fed must raise rates to cool off inflation, but it can’t increase rates too high or it could cause a recession.
It will take a little while to see whether rate increases can tame inflation. But tighter monetary policy will have an immediate impact on your finances, from how much you pay to borrow money to the interest you can earn in your savings account, to whether or not you should refinance your mortgage.
4 Ways The Fed Rate Increase Can Affect Your Money
Fed rate increases have a pretty ambiguous impact on the stock market. On the one hand, higher rates may incentivize some investors to take profits and sell stocks. But there’s plenty of evidence that over the longer term, rate hikes don’t hurt stocks.
In the short term, the most significant immediate impact of rate increases is on market psychology. When the FOMC raises rates, professional traders might quickly sell stocks and move into more defensive investments, without waiting for the complicated process of higher rates to work their way through the economy.
But over the longer term, the data shows that stock markets can rise in some cases when the Fed is tightening monetary policy.
Dow Jones Market Data analyzed the five most recent rate hike cycles to see what history says about stock market returns in these periods. Their analysis showed that during these five long-term periods, the three leading stock market indexes only declined during one rate hike cycle, in June 1999 to January 2001, during the dot-com crash.
When the Federal Reserve raises its benchmark interest rate, your credit card debt becomes more expensive. That’s because the interest rates on consumer debt like carrying a balance on a credit card tend to move in lockstep with the Fed’s rate.
The federal funds rate impacts how much commercial banks charge each other for short-term loans. A higher fed funds rate means more expensive borrowing costs, and that can depress demand among banks and other financial institutions to borrow money.
The banks pass on these higher borrowing costs by raising the rates they charge for consumer loans. Most credit card issuers set your APR based on the prime rate, which is the rate banks charge their least risky customers for a loan.
Most credit cards charge a variable APR based on a combination of the prime rate plus a percentage on top of that to cover both operating costs and make a profit.
The “variable” part means the interest rate you agree to pay when approved for a new card can fluctuate based on the prime rate. So if your credit card APR is 16.25% and the Fed increased its federal funds rate by .25 of a point, it’s likely your issuer will soon raise your APR to 16.5%.
The higher the interest rate that’s applied to your credit card balance, the more expensive it is to carry that debt. Consider paying your debt down as much as possible or take advantage of a 0% APR balance transfer card to help reduce how much extra money you’ll pay on your debt.
Related: Compare The Best Balance Transfer Cards
Fed rate hikes make it more expensive to borrow money for a home and other types of loans.
Mortgage rates are already on the rise, jumping 9 basis points last week to 3.85% for a 30-year, fixed-rate mortgage, according to the last Freddie Mac weekly report. Mortgage rates are not directly impacted by the fed funds rate; instead, tighter monetary policy tends to raise the 10-year Treasury yield, which has a direct impact on home loan rates.
If you have an adjustable rate mortgage or home equity line of credit (HELOC), it will likely rise as well. The actual interest rate offer you receive is also based on the individual lender, the type of asset securing the loan and your credit profile.
As for student loans, some private loans have rates tied to Fed rates, so there’s a possibility the interest rates on those could rise. All in all, it’s a good time to make sure you understand the loans you have, and consider refinancing them before rates increase more.
Related: Compare Current Mortgage Refinance Rates
Rising Fed interest rates are a good omen for savers, but it may take some time to see higher rates on bank deposits.
There’s no direct linkage between the federal funds rate and deposit rates. Banks eventually increase the annual percentage yield (APY) they pay on savings deposit accounts—including savings accounts, money market accounts and certificates of deposit (CDs)—but not right away. Banks generally raise rates to attract deposits, and they can be sluggish to increase yields when they have plenty of cash, which is the case currently.
How quickly you’ll see higher APYs on deposits depends on where you bank. Online banks, smaller banks and credit unions typically offer higher yields than big banks and may increase rates faster since they have to compete more for deposits.
Stashing your cash at an online bank or credit union may be your best bet if you’re looking for a higher yield. As of February 22, 2022, the national average savings account rate was 0.06% but some of the best high-yield savings accounts pay 0.50% APY. Where you park your cash matters, especially during times of increasing inflation.
Related: How The Fed’s Interest Rate Hike Will Affect Savings Accounts