You know that the Federal Reserve, which is the central bank of the United States, has raised interest rates every year since March 2022. The Fed is raising rates for the first time since 2018. The Federal Reserve’s primary objectives are to maintain stable prices and promote maximum employment. The central bank’s main goal is to maintain inflation at around 2% per year. Interest rates are the main tool it uses to influence inflation. The Fed sets the short-term lending rate for commercial bank, and these banks then pass on those rates to consumers and business. The Fed’s rate changes affect the interest rates we pay as consumers on credit cards and mortgages.
The majority of people who read this article know that when the Fed raises interest rates, everyone has to pay more for credit cards and loans to purchase large items such as cars or homes. The Fed should also increase rates on money markets and savings accounts to benefit consumers. How else can interest rate increases affect us? Here are five things to watch out for:
Stock Price
In general, the stock market does not move in the same direction as interest rates. However, historically they have moved in the opposite direction. Investors are often concerned about the profitability of companies when interest rates move up. The impact on companies that have significant international operations can be even worse, as a rate increase usually strengthens the US dollar. Companies can experience a real-terms decline in sales overseas as the US dollar increases against other currencies.
Bond prices
Interest rate hikes tend to send bond prices down, which is bad for fixed income investors. This is a scenario that the United States will never have seen before. This is the fastest rate of increase in interest rates in decades. It’s nearly twice as fast than in 1988-1989. The worst bond year in US history has resulted from this. Since 1977, the Bloomberg US aggregate index shows that bonds have only fallen in value five times. The highest fall was 2.9% in 1994. The iShares Core US Bond ETF (AGG), as of this writing, is down more than 16% since the start of 2022.
Home Price
High interest rates can often reduce demand for homes, which in turn affects their prices. Mortgage applications have been affected by higher mortgage rates. Mortgage applications had dropped by almost 30% in the past year as of September 1st. Prices fall when there is less demand for products.
Tax Increases?
A rate increase isn’t only a rise in interest rates for consumers. The borrowing costs of the US government are also increased. Medicare/Medicaid and Social Security will be the largest four items in the US National Budget by 2022. The estimated total deficit between 2022 and 2031 is $12.7 trillion. Just a.50% increase in rates would cause this deficit to rise by $1 trillion. How can the government pay off this debt? The government doesn’t make extra money selling hot dogs and hamburgers. Taxes are the main source of revenue for the government. Could there be a government that decides to raise taxes in order to solve the deficit problem? Perhaps.
Insurance Policy
There’s good news! It’s possible that the insurance company will increase their dividend and/or crediting rate if they are unable to match old rates on existing permanent policies such as whole life or universal life. Some carriers will switch to new products with better benefits. This will help new life insurance purchases, while legacy policyholders may be able to take advantage of the 1035 tax-free exchange in order to upgrade their policy.
Fed is expecting to increase its target rate by around 4.5% at the end of 2022, but they don’t expect inflation to reach their target of 2.5% until 2025. These higher rates may be around for some time. It is important to understand how higher rates may affect you, and what you can do to prepare for the future.
