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On March 16, the Federal Reserve delivered on its long-standing promise to raise interest rates to combat rising inflation. The Fed has come under pressure to take action to calm the price spikes that have pushed inflation to its highest level in 40 years.
“We expect inflation to remain elevated through the middle of the year,” Federal Reserve Chairman Jerome Powell said at the news conference following the Fed’s meeting.
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 last PCE readingfor the month of January, which measured prices up 6.1% from the previous 12 months.
Americans worry about the rapidly rising costs of everyday items like groceries and gas, so it may seem counterintuitive to increase the cost of borrowing money when the finances of people are already tense.
However, higher interest rates — this decision is only the first several rate hikes planned increases in 2022 – should moderate demand for goods, which in turn may reduce inflation.
Why is the Fed raising rates?
For months, Powell and other Fed officials kept repeating that four-decade highs in U.S. inflation rates made tighter monetary policy an absolute necessity. It has also become clear that the labor market has almost fully recovered as the Covid-19 pandemic subsides.
Congress has given the Fed two tasks: to keep prices under control and to promote full employment. It looks like the latter job is done, so the Fed is preparing to tackle the former by tightening monetary policy.
At the March meeting, the central bank raised the fed funds rate—that’s what we mean when we say “interest rate hikes”—by 25 basis points, to 0.25% at 0.50%. But that’s just the first leg of a longer journey: Analysts expect the Fed to make 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 calm inflation, but it can’t raise rates too high or it could cause a recession.
It will take some time to see if rate hikes can bring inflation under control. 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 on your savings account, to whether or not you need to refinance your mortgage. .
4 Ways the Fed Rate Hike Can Affect Your Money
1. Fed rate hikes affect the stock market, but not necessarily what you think
Fed rate hikes have a rather ambiguous impact on the stock market. For one thing, higher rates may induce some investors to take profits and sell stocks. But there’s plenty of evidence that over the longer term, rate hikes aren’t hurting equities.
In the short term, the most significant immediate impact of rate hikes is on market psychology. When the FOMC raises rates, professional traders can quickly sell stocks and switch to more defensive investments, without waiting for the complicated process of rising rates to play out in the economy.
But longer term, the data shows that stock markets can rise in some cases when the Fed tightens monetary policy.
Dow Jones Market Data analyzed the five most recent rate hike cycles to see what history says about stock market returns during those periods. Their analysis showed that over these five long-term periods, the three major equity indices fell only during a cycle of rising rates, from June 1999 to January 2001, during the dot-com crash. .
2. Credit card interest is getting more expensive
When the Federal Reserve raises its benchmark interest rate, your credit card debt becomes more expensive. This is because interest rates on consumer debt, such as carrying a balance on a credit card, tend to move in step with the Fed rate.
The federal funds rate affects how much commercial banks charge each other for short-term loans. A higher federal funds rate means higher borrowing costs, which can lower the demand for banks and other financial institutions to borrow money.
Banks are passing 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 lowest-risk customers for a loan.
Most credit cards charge a variable APR based on a combination of the prime rate plus an extra percentage to cover both operating costs and earn a profit.
The “variable” part means that the interest rate you agree to pay when a new card is approved can fluctuate depending on the prime rate. So if your credit card’s APR is 16.25% and the Fed has raised its federal funds rate by 0.25 points, chances are your issuer will soon increase your APR to 16.5%.
The higher the interest rate applied to your credit card balance, the more expensive it is to pay off that debt. Consider paying off your debt as much as possible or take advantage of a 0% APR balance transfer card to help reduce the extra amount you’ll pay on your debt.
Related: Compare the best balance transfer cards
3. Mortgages and loans are getting more expensive
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 Freddie Mac’s latest weekly report. Mortgage rates are not directly affected by the federal funds rate; instead, tighter monetary policy tends to raise the 10-year Treasury yield, which has a direct impact on mortgage rates.
If you have an adjustable rate mortgage or home equity line of credit (HELOC), it will likely increase 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 interest rates on those may increase. Overall, now is a good time to make sure you understand the loans you have and consider refinancing them before rates rise further.
Related: Compare Today’s Mortgage Refinance Rates
4. Fed rate hikes are good for savings accounts — eventually
The Fed’s interest rate hike bodes well for savers, but it may take some time to see higher rates on bank deposits.
There is no direct link between the federal funds rate and deposit rates. Banks end up increasing 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 now. Banks typically raise rates to attract deposits, and they can be slow to raise yields when they have plenty of cash, which they currently do.
How quickly you’ll see higher APYs on deposits depends on where you bank. Online banks, smaller banks, and credit unions generally offer higher yields than larger banks and can raise rates faster because they have to compete more for deposits.
Hiding your money in an online bank or credit union may be your best bet if you’re looking for a higher return. As of February 22, 2022, the national average savings account rate was 0.06%, but some of the top high-yield savings accounts pay 0.50% APY. Where you park your money is important, especially in times of rising inflation.
Related: How the Fed’s Interest Rate Hike Will Affect Savings Accounts