The good news and bad news of the Fed rate hike. What does it mean to you


The Federal Reserve is stepping up its fight against inflation. This means that the cost of borrowing for families and businesses is rising rapidly.

The US Federal Reserve raised interest rates by three-quarters of a percentage point on Wednesday, the largest single hike since 1994.

It follows the Fed’s decision in May to raise interest rates by half a percentage point, the largest hike in 22 years.

The fact that the Fed is acting decisively shows confidence in the health of the labor market. But the pace at which interest rates are expected to rise underscores growing concerns about rising costs of living.

High inflation – consumer prices rose at their fastest pace in 40 years in May – is likely to force the Fed to raise interest rates several times in the coming months. Fed officials may resort to extra-large rate hikes to calm inflation.

Americans will experience this policy shift first through higher borrowing costs: It’s no longer incredibly cheap to take out a mortgage or car loan. And the money sitting in bank accounts will eventually yield something, though not much.

The Fed speeds up or slows down the economy by raising or lowering interest rates. When the pandemic struck, the Fed made borrowing virtually free to spur household and corporate spending. To further boost the Covid-ravaged economy, the US Federal Reserve also printed trillions of dollars through a program called quantitative easing. And when credit markets froze in March 2020, the Fed introduced emergency lending facilities to avoid a financial crisis.

The Fed’s defense worked. There was no Covid financial crisis. Congressional vaccines and massive spending paved the way for a speedy recovery. However, its emergency measures – and their belated removal – also contributed to the overheating of the economy today.

Unemployment is currently near a 50-year low, but inflation remains very high. The US economy no longer needs as much help from the Fed. And now the Fed is slowing down the economy by aggressively raising interest rates.

The risk is that the Fed overdoes it and slows down the economy so much that it inadvertently triggers a recession that drives up unemployment.

Borrowing costs are rising

Every time the Fed raises interest rates, it becomes more expensive to borrow. That means higher interest costs on mortgages, home equity loans, credit cards, student loans, and auto loans. Business loans for large and small companies are also becoming expensive.

The most compelling way to do this is with mortgages, where rate hikes have already raised rates and slowed selling activity.

The 30-year fixed-rate mortgage rate averaged 5.23% at the end of the week June 9th. It has risen sharply from less than 3% around this time last year.

Higher mortgage rates are making it harder to afford the home prices that have skyrocketed during the pandemic. This weak demand could cool prices.

According to the National Association of Realtors, the median price of an existing home sold in April rose 15% year over year to $391,200.

How high will rates go up?

Investors expect the Fed to raise the upper end of its target range from 1% to at least 3.75% by the end of the year.

For comparison, the Fed hiked rates to 2.37% during the peak of the last rate hike cycle in late 2018. Before the Great Recession of 2007-2009, Fed rates reached 5.25%.

And in the 1980s, the Fed, led by Paul Volcker, raised interest rates to unprecedented levels to combat runaway inflation. By the time it peaked in July 1981, the effective fed funds rate had risen to over 22%. (Borrowing costs are nowhere near that level now, and there is little hope that they will rise anytime soon.)

Still, the impact on borrowing costs over the coming months will depend largely on the pace of Fed rate hikes – currently undetermined.

Good news for savers

Low prices punish savers. Money held in savings deposits, certificates of deposit (CDs) and money market accounts has earned almost nothing during Covid (and for the past 14 years, for that matter). Measured against inflation, savers lost money.

The good news, however, is that if the Fed raises interest rates, these savings rates will increase. Savers earn interest again.

But it takes time to play. In many cases, particularly with traditional accounts at large banks, the impact will not be felt overnight.

And even after several rate hikes, savings rates will still be very low – well below inflation and expected stock market returns.

The markets will have to adapt

Free money from the Fed has been wonderful for the stock market.

Zero interest rates drive down government bond yields, essentially forcing investors to look to riskier assets like stocks. (Wall Street even has a term for it: tina, meaning “there is no choice.”)

Higher interest rates have been a major challenge for the stock market Addicted – if not addicted – easy money. US stocks tumbled in a bear market on Monday amid fears that the Fed’s aggressive rate hike would push the economy into recession.

The ultimate impact on the stock market will depend on how quickly the Fed hikes rates – and how the underlying economy and corporate earnings evolve.

At the very least, the rate hike means the stock market faces more competition from boring government bonds.

Cooler inflation?

The Fed’s rate hike aims to keep inflation under control while maintaining the job market recovery.

According to the latest data from the Labor Department, consumer prices rose 8.6% year over year in May, the fastest pace since December 1981. Inflation is nowhere near the Fed’s 2% target and has accelerated in recent months deteriorated.

Economists have warned that inflation could get worse as gas prices hit record highs in recent days, accelerating the rise that began in the wake of Russia’s invasion of Ukraine.

Everything from food and energy to metals has become expensive.

The high cost of living is a financial headache for millions of Americans and a major contributor to record-low consumer sentiment, not to mention President Joe Biden’s low approval rating.

However, it will be some time before the Fed hikes interest rates to curb inflation. And yet, inflation will continue to be subject to the development of the war in Ukraine, supply chain disruptions and, of course, Covid.

CNN’s Kate Trafecante contributed to this report.

Good news and bad news after the Fed hike. What That Means For You appeared first on CNN.



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