Five ways the Fed’s interest rate hikes will impact Americans

The Federal Reserve Bank on Wednesday announced an interest rate hike of 75 basis points, a 50% higher increase than the central bank originally announced for June.

The move comes after inflation hit a new 40-year high last week, with consumer prices rising 8.6% from where they were a year ago.

Fed watchers predict the bank’s benchmark federal funds the rate will continue to rise throughout the year, perhaps at a faster rate than expected if prices do not fall.

Even with the rate hike, interest rates will still only be around 1.6%, close to all-time lows.

Here are five ways a rising interest rate environment will affect Americans’ wallets and economies:

Mortgage, car and credit card payments will increase

The federal funds rate sets the rate at which banks and credit unions can lend money to each other when determining their capital needs to make investments in the economy.

Banks that borrow money at the federal funds rate must then charge a comparable rate to the people and institutions that borrow money from them. Thus, an increase in the funds rate translates to higher rates in credit markets, mortgage markets, and any industry that relies on financing plans to make payments.

This means higher monthly house and car payments and a higher price tag on unpaid credit card debt.

Mortgage rates are already experiencing strong increases. Interest payments for benchmark 30-year U.S. fixed-rate mortgages jumped the biggest one-week jump in 35 years, hitting 5.78% on Thursday, up more than half a percentage point from the previous week.

This means that a mortgage payment on a home with a median value of $400,000, after a 20% down payment, would now be around $1,875. Last year, the monthly payment on the same house would have been $1,335. That’s more than a $500 per month difference.

Stock markets fall and experience dramatic price swings

These higher prices that consumers pay mean that people tend to limit their spending, which lowers the demand for goods and services. The consequence for companies is a decrease in profits, which means that investors become less willing to pay for shares of ownership, leading to falling stock prices.

Since January, most major US stock indexes have fallen by around 20%, entering what is known as a bear market or an extended period of falling stock prices.

The Dow Jones Industrial Average has fallen 18.6% this year, plunging below 30,000 on Thursday after a January high of 36,800. The S&P 500 index fell below 3,700 from a high of 4,800, a drop of more than 22% over the same period.

The tech-heavy Nasdaq, whose companies tend to take on more debt, making them particularly sensitive to interest rate hikes, fell more than 30%.

Since March, when the Fed began raising interest rates with a modest target range of 25 to 50 basis points, the Dow Jones has fallen 12%, the S&P 16% and the Nasdaq 20%.

it will be harder to find a job

Price increases that reduce demand also have the effect of forcing businesses to cut costs, and one of the first places they look to do this is in the workforce.

The housing market provides a clear example of this process, according to Desmond Lachman, an economist at the American Enterprise Institute (AEI), a right-wing think tank in Washington.

Mortgage rates that “were just over 3% at the start of the year are now around 6%. This means that people who could afford a house for $100 at the start of the year can only afford a house for around $70 now. That means there’s a lot less demand for houses, so house prices start to level off and go down, and so builders don’t want to build as many houses, and then people don’t get employed,” he said. said Lachman in an interview with The Hill. .

While that may sound like a bad thing, it has longer-term positive effects for an economy that is seeing some of the highest levels of employment in decades, with around 96.4% of job seekers currently employed and 11.4 million jobs currently open, according to the Ministry of Labor.

Having a looser labor market means companies don’t have to keep charging higher prices in order to generate profits for their investors, which can lower inflation and stretch the value of a dollar.

So while higher rates will mean an end to the nominal wage gains that benefited workers during a time of labor shortages, the increased purchasing power of the dollar should add real value to paychecks. pay.

The probability of a recession increases

As the Fed pursues a “soft landing” for the economy – lowering inflation to 2% without triggering a recession – many market commentators view a recession of a year or two as increasingly likely.

“I’m not as worried about a return to 1970s inflation levels as I am about a deep recession that will soon bring inflation down,” Lachman said.

Fears of a severe recession, or the combination of slowing growth and a low-valued currency known as “stagflation,” are now compounded by geopolitical issues that go beyond the reach of the monetary policy levers held by the Fed.

These include the war in Ukraine, which has had an effect on global food prices, as well as blockages in China, which have affected production pipelines. Wider problems with supply chains, which have been thwarted by exorbitant energy prices and congestion at ports, are also powerful forces weighing on the global economy.

A recession for Americans following interest rate hikes will be a double-edged sword. While this will lower prices in the medium term, it will also mean a period of reduced economic activity. This will translate into lower returns on investments in the stock market and other securities markets, poorer performance of retirement plans like 401(k), and lower nominal wages.

The national deficit will cost (taxpayers) After

With interest rates at or near zero, economists tend not to worry about the federal deficit, which is currently worth about a year and a quarter of productive output, or gross domestic product ( GDP).

The resounding economic recovery experienced by the American economy after the almost total shutdown of the private sector due to the pandemic has reduced the American public debt. The Congressional Budget Office’s latest deficit projection was $1.7 trillion lower than expected.

But with rising interest rates, good surprises like this will be increasingly rare, as paying down the national debt will require more taxpayers’ money.

“The government is going to have to shell out more in interest payments,” said AEI’s Lachman. “On top of that, what’s going to happen in the progress we’ve made in deficit reduction is also going to go away, because as the economy collapses and goes into recession, that means the government is going to collect less taxes.”

Lachman added, “The wrong thing to do for the Fed was – especially after the Biden package of $1.9 trillion, 8% of GDP, the type of fiscal stimulus we’ve never had before in times of peace – the Fed just sat with interest rates at zero and then kept convincing itself that inflation was transitory and had nothing to do with the fact that the money supply grew by 40% in two years. It was crazy.

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