The Federal Reserve increased interest rates to a range between 1.5 percent and 1.75 percent, the first of three scheduled increases for this year, following their announcement last Wednesday. Even before the Fed’s announcement, industry analysts discussed their worries over the rates increasing too much that could be aggressive on market outlook. This has left some consumers to wonder how this increase could affect their everyday expenses. While the increase turned out to be fair, it’s impact on investments and spending are enough to affect individuals’ consumption.
The interest rate determined by the Fed is the Federal Funds Rate, an amount banks charge when trading funds with each other. The Fed increased the interest rate by 0.22 percent at the end of 2015, which was the first significant rate increase since the recession. They followed with a 0.25 percent increase a year later, before making more regularly scheduled interest rate increases in 2017.
The interest rate is important to borrowers since any change to the rate influences how much banks charge people for mortgages, credit cards and other types of loans and credits. Hence, a rise in the interest rate also increases how much you’ll be charged for loans. However, these increases affect short-term loans much more than long-term loans. Credit cards and mortgages are considered long-term loans as, generally, a holder to these loans should meet their monthly payments without incurring any outstanding balances.
As Equifax’s Chief Economist Amy Cutts states, banks and other lenders make minimal increases to their long-term loan rates consistently to offset incoming rate hikes and maintain their lending business. For example, data from Freddie Mac shows that both the 30-year and 15-year fixed-rate mortgages (FRMs) increased by 0.01 percent since the Fed’s interest rate announcement. These FRM home-buying loans are now up to 4.45 percent and 3.91 percent, respectively. Thus, long-term loans rise by increments compared to short-term business loans, the rates of which follow along with the Fed’s increases exactly.
As current interest rates are much lower than those prior to the recession, the rate increase would have a slight effect on individuals wanting to buy luxury goods, such as a home or appliances, in addition to purchasing food and other staple goods. However, this would be the case if goods and services were independent from recent fiscal changes.
As mentioned before, business loans follow the Fed’s increases to the interest rate precisely. The reason behind this is that the rate banks charge for these loans is the Prime Rate, which is determined by the Federal Funds Rate. Businesses and corporations regularly take out these loans to increase their capital to keep producing their goods. Hence, the costs of capital will rise with each percent increase the Fed imposes on interest rates.
Additionally, the tariffs on steel and aluminum may increase the difficulty in maintaining capital investment. The 10 percent and 25 percent tariffs on the respective aluminum and steel imports will impact the manufacturing industry more heavily than others, as well as related industries that rely on these materials. Thus, these tariffs, coupled with the increase in interest rates, will have a compound effect on the revenue of aluminum and steel-dependent industries. Therefore, it’s probable that corporations in these sectors will either raise their prices or cut production costs, with job losses a more potential outcome with the latter course.
These corporate changes would not only affect consumers, but investors as well. A decrease in company earnings can devalue its stocks and affect the rate of return an investor gains or lose from the stock. This will make stocks in aluminum and steel-dependent industries seem riskier than before. Moreover, the Trump administration’s recent announcement about potentially placing tariffs on technology and communication-related imports from China have renewed market worries over productivity for these companies and how it’ll negatively impact investments.
Despite the upcoming fiscal changes that seem worrisome, the economy has proved that we are still due for growth that can lessen this pressure. The recent tax cut for corporations can offset capital expenses, providing businesses at least some reprieve from tariffs and increased interest. This could help businesses maintain their ordinary levels of revenue and calm potential market volatility. Similarly, the expected increase in individual tax returns should allow consumers to afford goods at higher prices.
However, consumers might also want to put some of their new income into savings accounts as higher interest rates make room for higher returns. A Money Market account and a Certificate of Deposit are two types of interest-bearing accounts whose rates increase with the rise in the Prime Rate. Money market accounts pay a higher interest than a normal savings account and allows you to withdraw or write a check with those funds, albeit a limited amount of times, at no extra charge. The bank or lender that manages the account will also invest it in low-risk assets, such as Certificates of Deposit (CD).
A CD is a fixed maturity deposit, or a deposit with a set a due date for returns, with a fixed interest rate that can either be paid out or reinvested at the end of its term. It’s offered in a variety of fixed date ranges such as 3, 6, 9 and 12 months. There are longer terms that are offered for CDs, but with the Fed expected to increase interest rates more regularly over the coming years the short-term CD’s might prove to be more lucrative. However, a disadvantage that CDs hold are penalty fees for withdrawing funds from the account. Yet, even with their limitations, these savings accounts are good options to look at during times of interest rate increases.
Although consumers should keep themselves informed on the Fed’s changes to the interest rates, our economy is not in such a dire situation that we should be obsessively worried over it. In fact, our economy has provided evidence since the year began that we are on the road towards economic recovery. While we’ll see major changes occur in some industries on both the supply and demand sides, we should be able to accommodate for these changes to our consumption.