How the Fed’s rate hikes slow the economy — and impact you (2023)

FAQs

How does the Fed rate hike affect me? ›

Credit Card Interest Becomes More Expensive

A higher fed funds rate means more expensive borrowing costs, which can reduce demand among banks and other financial institutions to borrow money. The banks pass on these higher borrowing costs by raising the rates they charge for consumer loans.

Cons. Another potential result of higher interest rates: Businesses may pull back on borrowing and investing, which means consumers and businesses would start spending less and eventually bring demand back down to a level that's commensurate with supply.

What Happens When the Fed Raises Rates? When the Fed raises the federal funds target rate, the goal is to increase the cost of credit throughout the economy. Higher interest rates make loans more expensive for both businesses and consumers, and everyone ends up spending more on interest payments.

The Federal Reserve seeks to control inflation by influencing interest rates. When inflation is too high, the Federal Reserve typically raises interest rates to slow the economy and bring inflation down.

With higher interest rates, interest payments on credit cards and loans are more expensive. Therefore this discourages people from borrowing and spending. People who already have loans will have less disposable income because they spend more on interest payments. Therefore other areas of consumption will fall.

Rising interest rates typically make all debt more expensive, while also creating higher income for savers. Stocks, bonds and real estate may also decrease in value with higher rates. You can take defensive action to help prepare for bad economical times while growing your overall finances.

It Could Trigger a Recession and a Rise in Unemployment

If the Fed raises rates too high and too quickly, it could cool demand so much that the economy tips into a recession. Higher interest rates make debt costlier and borrowing harder — for both consumers and businesses.

Economists generally believe that the interest rate hikes of 2022 will eventually lead to a recession and a return to cheaper borrowing rates.

Take advantage of rising interest rates by maximizing your savings, investing in bonds and refinancing high-interest debt before rates go higher. Oct. 3, 2022, at 9:59 a.m. The Federal Reserve raised interest rates in September for the fifth time this year in an effort to cool rising inflation.

Generally, longer-maturity bonds come with a longer duration, meaning that they'll decline more in value in response to hikes in interest rates. Shorter-term bonds will tend to hold up better during rising rate regimes. One investment everyone would be wise to consider, at least according to Suze Orman: series I bonds.

What happens to real estate when interest rates rise? ›

As mortgage rates rise, the effect on real estate investing can be positive. The market for rental properties will increase because fewer people can qualify for mortgages. That said, rising interest rates reduce prices, so it can sometimes be better to buy during a rising interest rate environment.

Rising interest rates won't impact existing federal loans, which have fixed interest rates, but could make future student loans more expensive. If you have fixed-rate private loans, those rates won't change either, but the rate on variable-rate loans will very likely rise.

Market conditions

Fed officials often say “tighter financial conditions” aimed at slowing down the economy are among the intended goals of interest rate hikes. That extends to credit spreads, equity prices and the strength of the U.S. dollar, all of which respond to higher interest rates.

How does the Fed lower inflation? The Fed's top tool for controlling inflation is its power to affect interest rates. The Fed can raise or lower its benchmark rate — known as the federal funds rate — based on what it is seeing in the economy.

Contractionary monetary policy is now a more popular method of controlling inflation. The goal of a contractionary policy is to reduce the money supply within an economy by increasing interest rates. 5 This helps slow economic growth by making credit more expensive, which reduces consumer and business spending.

1. Collectors. Historically, collectibles like fine art, wine, or baseball cards can benefit from inflationary periods as the dollar loses purchasing power. During high inflation, investors often turn to hard assets that are more likely to retain their value through market volatility.

Rising interest rates affect home affordability for buyers by increasing the monthly mortgage payment. Despite how it seems, there are benefits to buying when interest rates rise. Less buyer competition forces home sales prices down, opens up more choices for buyers and can reduce buyer risk.

Even so, interest rate hikes are known as the central bank's one major tool to lower inflation, which it does by raising the cost of borrowing money to curb the demand for goods and services.

You can deal with a rise by using these tips: reduce expenses so you have more money to pay down your debt. pay down the debt with the highest interest rate first to pay less interest over the term of your loan. consolidate high interest debts, such as credit cards, into a loan with a lower interest rate.

Who benefits and who is hurt when interest rates​ rise? Corporations with immediate capital construction needs are worse off. Households with little debt, saving a significant fraction of annual income for retirement, are better off. The federal government running persistent budget deficit is worse off.

What are the pros and cons of rising interest rates? ›

One of the biggest “pros” to higher interest rates are the higher savings returns that can be earned in a savings account. Conversely, when interest rates are rising, business and consumers cut back on spending as increases in prices on goods resulting in lower consumption.

According to the NBER's definition of recession—a significant decline in economic activity that is spread across the economy and that lasts more than a few months—we were not in a recession in the summer of 2022.

When demand peaks and starts to decline, the excessive supply of goods and services that aren't consumed can lead to a recession, with companies producing less and downsizing while people lose purchasing power and consumption continues to fall.

One of the safest places you can put your money during a recession is in Treasury bonds. Treasury and savings bonds are issued by the U.S. government and are backed by the full faith and credit of the U.S. government. That means they're about as safe as investments come.

The best places to save money and earn interest include high-yield savings accounts, interest-bearing checking accounts, money market accounts, certificates of deposit (CDs), and Treasury savings bond accounts.

The bottom line. The housing industry makes up a large part of the U.S. economy. With interest rates rising, you can expect home prices to cool off and drop. The impact this will have on industries connected to the housing market varies.

Less expensive tangible assets that do well during inflation include many types of commodities. Agricultural commodities like wheat, corn, soybeans, livestock and timber are among such commodities. Industrial metals like nickel, copper and steel also tend to do well during inflation.

Will 2023 be a good time to buy a house? ›

Mortgage rates are sky-high, inventory is low, and prices are still elevated from their pandemic spikes—making it a less than ideal time to buy. “Homebuyers and renters hoping for some financial relief in 2023 will likely be disappointed,” writes Clare Trapasso for Realtor.com.

Consumers can almost immediately feel the Fed's impact. When the Fed's rate rises, so too do rates on credit cards, home equity lines of credit (HELOCs), auto loans and adjustable-rate mortgages (ARM), as well as yields on certificates of deposit (CDs) and savings accounts.

The Fed's decisions influence where banks and other lenders set interest rates. Higher Fed interest rates translate to more expensive borrowing costs to finance everything from a car and a home to your purchases on a credit card.

If inflation is kept to a minimum by the Fed's benchmark interest rate, prices for things you buy every day—think groceries or personal care items—have less room to increase. If a Fed rate change keeps those everyday prices low, you can put more of your money toward savings or paying off high-interest debt.

BLS data showed that inflation eased on July to 8.5% from the 40 year peak reached on June at 9.1%. Annual inflation increased to 8.3% in August 2022, in part due to rising grocery prices. In September the Fed increased the interest for a fifth time in the year reaching a 14 year high.

There are many ways to increase your income during inflation. You can invest smartly in your employer-sponsored retirement plan, in fixed rate bonds, find ways to increase your active income, earn from passive income sources or investments, or invest in entities and commodities that rise with inflation.

The Fed has several tools it traditionally uses to tame inflation. It usually uses open market operations (OMO), the federal funds rate, and the discount rate in tandem.

In an inflationary environment, unevenly rising prices inevitably reduce the purchasing power of some consumers, and this erosion of real income is the single biggest cost of inflation. Inflation can also distort purchasing power over time for recipients and payers of fixed interest rates.

Look for savings

Eliminate any fees you pay for credit cards or bank accounts (late fees, monthly or annual service fees, ATM fees, etc.). Many banks are waiving such fees and credit cards often have fee-free options. Renegotiate bills like cable, streaming or cell phone for any possible savings.

What can you buy before inflation gets worse? ›

Commodities like gold, oil, and even soybeans should increase in price along with the finished products that are made with them. Inflation-indexed bonds and Treasury Inflation-Protected Securities (TIPS), tend to increase their returns with inflationary pressures.

1. The Fed's decisions influence where banks and other lenders set interest rates. Higher Fed interest rates translate to more expensive borrowing costs to finance everything from a car and a home to your purchases on a credit card.

Action items when interest rates are rising: Shop for a higher-yielding online savings account to take advantage of higher rates. Pay down your credit card debt; consider a balance transfer credit card. If you're shopping for a home, make sure your mortgage preapproval reflects current interest rates.

When interest rates rise, it's usually good news for banking sector profits since they can earn more money on the dollars that they loan out. But for the rest of the global business sector, a rate hike carves into profitability. That's because the cost of capital required to expand goes higher.

In most cases, higher interest rates mean a stock market that declines in value. This is because when interest rates rise, companies will borrow less money. The result is their earnings will grow at a slower rate than investors anticipate. This has a ripple effect across all sectors of the stock market.

The Fed raises interest rates to slow the amount of money circulating through the economy and drive down aggregate demand. With higher interest rates, there will be lower demand for goods and services, and the prices for those goods and services should fall.

“While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses,” he said in a recent speech.

Financial services, which can include banks, insurance firms and brokerage companies, is one of the key industries that benefits from a sharp rise in interest rates. For example, profit margins can increase during this time, especially with banks. With higher rates, banks can charge higher rates on consumer loans.

Generally, longer-maturity bonds come with a longer duration, meaning that they'll decline more in value in response to hikes in interest rates. Shorter-term bonds will tend to hold up better during rising rate regimes. One investment everyone would be wise to consider, at least according to Suze Orman: series I bonds.

Some sectors within the stock market are more sensitive to changes in interest rates compared to others. Financials benefit from higher rates through increased profit margins. Brokerages often see an uptick in trading activity when the economy improves and in higher interest income from higher interest rates.

Where does money go when Fed raises rates? ›

Once the economy starts to recover a central bank may partially or fully reverse those policies to stem inflation. Economists generally believe that the interest rate hikes of 2022 will eventually lead to a recession and a return to cheaper borrowing rates.