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Thursday, January 27, 2022

Rate hikes are coming: What does that mean for you? - CNN

New York (CNN Business)The Covid era of free money is coming to an end.

After dropping interest rates to zero in March 2020 to revive the economy, the Federal Reserve is shifting gears and going into inflation-fighting mode.
Fed officials indicated Wednesday they plan to raise interest rates in March, launching a series of rate hikes for the first time since 2015.
Americans will experience this policy shift through higher borrowing costs: No longer will it be insanely cheap to take out mortgages or car loans. And money in the bank will finally earn something, albeit not much.
"Money will no longer be free," said Joe Brusuelas, chief economist at RSM US.
When the pandemic erupted, the Fed made it almost free to borrow in an effort to encourage spending by households and businesses. And to further boost the Covid-ravaged economy, the US central bank also printed trillions of dollars through a program known as quantitative easing and rolled out emergency credit facilities.
The Fed's rescue worked. There was no Covid financial crisis. Vaccines and massive spending from Congress paved the way for a rapid recovery.

Borrowing costs are going up

Today, unemployment is very low but inflation is very high. The US economy no longer needs all that help from the Fed.
Every time the Fed raises rates, it becomes more expensive to borrow. That means higher interest costs for mortgages, home equity lines of credit, credit cards, student debt and car loans. Business loans will also get pricier, for businesses large and small.
The most tangible way this is playing out is in mortgages, where expectations of rate hikes have already driven up rates.
The average rate for a 30-year fixed rate mortgage recently hit 3.55%, the highest level since March 2020. That's up sharply from 3.05% as recently as December 23.
Higher mortgage rates will make it harder to afford home prices that have skyrocketed during Covid. Weaker demand also could cool off prices, which have begun to decelerate in recent months.

But it'll still be relatively cheap to borrow

None of this means it will suddenly become expensive to finance purchases.
Investors are currently pricing in a 60% chance that there will be five interest rate hikes this year versus only a few months ago, when hardly any were priced into the market.
And if there are five rate hikes, the midpoint of the fed funds rate would be sitting at a relatively low 1.375%.
For context, the Fed raised rates to as high as 2.37% during the peak of the last rate hiking cycle in late 2018. And before the Great Recession of 2007-2009 Fed rates got as high as 5.25%.
And in the 1980s, the Paul Volcker-led Fed jacked interest rates up to unprecedented levels to fight runaway inflation. By the peak in July 1981, the effective Fed funds rate topped 22%. (Borrowing costs now won't be anywhere near those levels and there is little expectation that they will go up that sharply.)
Still, the impact to borrowing costs in coming months will depend chiefly on the speed of the Fed's rate hikes. There remains much debate about that, although Chairman Jerome Powell said Wednesday he believes there is "quite a bit of room" to raise rates without threatening the jobs market.

Good news for savers

Rock-bottom rates have penalized savers. Money stashed in savings, certificates of deposit (CD) and money market accounts has earned almost nothing during Covid (and for much of the past 14 years, for that matter). Measured against inflation, savers have lost money.
The good news, however, is that these interest rates will rise as the Fed gets away from zero. Savers will start to earn interest again.
But this takes time to play out. In many cases, especially with traditional accounts at big banks, the impact won't happen be felt overnight.
And even after several rate hikes, savings rates will still be very low -- below inflation and expected returns in the stock market.

Markets will have to adjust

All this free money has been amazing for the stock market. Zero percent interest rates depress government bond rates, essentially forcing investors to bet on risky assets like stocks. (Wall Street even has an expression for this: TINA, which stands for "there is no alternative.")
Higher rates could be a challenge for the stock market, too, which has become accustomed to -- if not addicted to -- easy money. Markets have already experienced significant volatility amid concerns about the Fed's plan to fight inflation.
But much will depend on how fast the Fed raises interest rates -- and how the underlying economy and corporate profits perform after they do.
At a minimum, rate hikes mean the stock market will face more competition going forward from boring government bonds.

Cooler inflation?

The goal of the Fed's interest rate hikes is to get inflation under control.
Consumer prices spiked by 7% in December from the year before, the fastest rate of inflation in 39 years. Inflation is nowhere near the Fed's goal of 2%.
The high cost of living is causing financial headaches for millions of Americans and contributing significantly to relatively low levels of consumer confidence, not to mention President Joe Biden's low approval ratings.
Yet it will take time for the Fed's interest rate hikes to start chipping away at inflation. And even then, inflation will still be subject to the whims of the supply chain mess, strong demand. And, of course, Covid.

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Rate hikes are coming: What does that mean for you? - CNN
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