The Federal Reserve has announced a rate hike of 0.25 percentage points following the rate hikes from January 31st to February 31st. In one meeting, it pushed the federal funds rate into the target range of 4.5% to 4.75%. The move prompted the Federal Reserve to raise interest rates eight times in a row in an effort to rapidly reduce liquidity to financial markets and curb high inflation.
The Federal Reserve’s decision came in December 2022 when inflation hit 6.5%, still the highest level in decades. With the Fed putting the brakes on an overheated economy, the main question for many market watchers is how far the Fed will go in raising rates and how deep the recession will be afterward.
CFA’s Greg McBride, Chief Financial Analyst at Bankrate, said: “Interest rates are rising and could last longer than is commonly believed.”
In addition to raising rates, the Fed is selling a huge amount of its bond portfolio. The move will help drain liquidity from the financial system to slow inflation as the Federal Reserve runs out of balance sheets.
The 10-year Treasury is at about 3.5%, well below its 52-week high of 4.33% reached just in October. Falling yields, even as the Fed continues to raise short-term rates, suggests investors are bracing for an impending recession.
As the Fed continues to hike rates, here are the winners and losers according to the latest decision:
1. Savings account and CD
Rising interest rates mean that banks will provide more returns on savings and money market accounts, but at different rates.
“The combination of rising interest rates and easing inflation is the best of both worlds for savers,” says McBride. “The highest yielding savings accounts, money market accounts, and CDs are well above 4% and most are still rising. A return of ~4.5% would be even better.”
Savers looking to maximize their return on interest should consider turning to online banks or top-tier credit unions, which typically offer far superior rates to those offered by traditional banks. .
With respect to CDs, account holders who have recently fixed interest rates will retain that yield for the duration of the CD unless they are willing to pay a penalty to break it.
“Multi-year maturity yields are currently peaking, so consider locking in longer-term CDs,” says McBride. “Yields on short-term CDs, savings accounts and money market accounts have a bit more leeway,” he said.
2. Mortgage
Federal funds rates don’t really affect mortgage rates, which are heavily dependent on 10-year Treasury yields, but they often move in the same way for similar reasons. With 10-year Treasury yields falling from their highs in recent months and market prices threatening a recession, mortgage rates have fallen sharply along with it.
“Inflation has peaked and is now calming down, but we’re seeing the same thing with mortgage rates,” says McBride. “The 30-year fixed-rate mortgage average has fallen to 6.4% after surpassing 7% in October. Lower inflation and slower economic growth suggest lower mortgage rates.”
Mortgage rates are well above the levels of a year ago, giving potential homebuyers a double whammy in the wake of home price surges over the past two years. Higher house prices and higher funding will lead to a slowdown in the housing market.
The cost of Home Equity Credit Lines (HELOCs) increases over time as HELOCs adapt relatively quickly to changes in federal funds rates. HELOC is usually associated with the prime rate, which is the rate that banks charge their highest customers. Your rate will increase if your HELOC has an outstanding balance. As interest rates rise, it can be a good time to compare and buy the best rates.
3. Stock and bond investors
Stock markets have surged as long as the Federal Reserve has kept interest rates near zero for an extended period of time. Low interest rates have been beneficial for equities, making them appear to be more attractive investments compared to fixed income investments such as bond rates and CDs.
Investors are pricing in rate hikes from late 2021 onwards, and the S&P 500 has been in a deep slump for most of 2022. Now that 10-year Treasury bonds have eased, stocks have risen in the past few months as investors believe they can see an end to rate hikes. Still, even if it doesn’t trigger a full recession, higher interest rates should slow growth and thus corporate earnings.
“Rising interest rates will be a headwind for corporate earnings, which will ultimately push stocks higher,” McBride said. “As with recent past episodes, Fed Chairman Jerome Powell may need to send a tough message that interest rates will be longer and higher than investors think. It will be a recipe for volatility.”
Rising interest rates hit bonds hard for most of 2022, pushing prices down. The longer a bond’s maturity, the more susceptible it is to rising interest rates. But now that investors are starting to put an end to aggressive Fed tightening, bond markets are finding a lower floor. However, stocks may still be in a precarious position as the economy has yet to withstand the expected recession.
If you’re looking for a safe place to stash your money while you wait for things to cool off, short-term rates are far more attractive.
The Federal Reserve’s continued cuts to its own bond portfolio should further erode support for stocks, bonds and even cryptocurrencies.
4. Borrower
If you’re an existing borrower and don’t need to tap the market for money, say you’re finalizing a 30-year fixed rate mortgage in 2021 or 2022, you’re in good shape. But credit cards (more on that later), student loans, personal loans, car loans, or whatever else you need to borrow is putting pressure on everyone else trying to access new credit.
According to Bankrate research, as of January 25, the average interest rate for personal loans is 10.6%. However, borrowers with good credit may have access to lower interest rates. The average interest rate in 2021 was just 9.38% when Fed Funds rates were near zero.
But not just these new borrowers, but those with all kinds of floating rate debt are feeling the pain of rising interest rates. For example, if you took out a variable rate mortgage years ago, that loan could reset at a higher interest rate, pushing up your monthly payments.
5. Credit card
Many variable rate credit cards change the rate they charge their customers based on the Prime Rate, which is closely related to the Federal Funds Rate. The Federal Reserve’s decision means that interest rates on floating rate cards will now move higher. Card fees are already at their highest in decades and continue to rise.
“Credit card rates will mimic this and any upcoming Fed rate hikes, and credit card rates, which are already at record highs, will rise further,” McBride said. Prioritize the repayment of your debt and take advantage of zero percent or other low-interest balance transfer offers to give these debt service efforts a boost.”
If you’re not running a balance, your credit card rate is seldom an issue.
6. U.S. FEDERAL GOVERNMENT
The national debt is over $31 trillion, and rising interest rates will drive up costs as the federal government rolls over debt and borrows new money. Governments, of course, have benefited for decades from prolonged interest rate declines. While interest rates can rise cyclically during boom times, they have fallen steadily over the long term.
As long as inflation remains higher than interest rates, governments are slowly taking advantage of inflation to repay their previous debt with today’s depreciating dollars. Of course, this is an attractive prospect for governments, but not for those who buy government bonds.
Conclusion
Inflation has been intense in recent years, and the Federal Reserve (Fed) has been aggressively raising interest rates to counteract it. So plan carefully how you will use it, such as being more discriminating when it comes to interest shopping in savings accounts and CDs. For those looking for some protection against inflation, one option is the Series I bond, which offers a solid 6.89% annual interest rate through April 2023.
