Consumers are already paying more for gas, groceries and everyday items, but should expect to shell out more in other parts of their lives after Wednesday’s interest rate hike.
The Federal Reserve’s decision to contain inflation will affect home mortgages, credit card borrowing, auto loans, labor market stability and overall consumption. The goal is to reduce the money supply in the economy.
“Too much money makes money less valuable,” said Larry Harris, professor of finance at the USC Marshall School of Business and former chief economist at the U.S. Securities and Exchange Commission. “To control inflation, the Fed has to stop creating so much money. And when it stops creating money, interest rates tend to rise.
Although the Fed does not set the interest rates that consumers pay on their credit cards, mortgages or personal loans, it does control the federal funds rate, which is the base rate at which banks borrow and lend themselves to each other. When things move, consumer interest rates also change.
Banks are required to have a certain amount of money in reserve, and when giving loans to people who want to buy houses, cars or start businesses, they may have to borrow from other banks to s ensure that they maintain this reserve number.
This time last year, the interest rate for borrowing from the general banking system was 0%, said Leo Feler, senior economist at UCLA Anderson Forecast. At this rate, banks were more than willing to lend to consumers because there was virtually no cost to covering their reserves. But now, with a higher interest rate range of 1.5% to 1.75%, banks will want to make sure they have enough reserves and act more cautiously, granting fewer home loans. , automobiles or otherwise, he said.
Financial markets were already pricing in higher interest rates — for example, mortgage rates hit 6%. The question is: how far will they go?
“The Fed has telegraphed that it’s going to keep raising rates until inflation goes down, no matter what,” Feler said.
Here’s what consumers can expect after Wednesday’s rate hike.
The rise in the Fed’s benchmark interest rates will affect the minority of households that take out variable rate mortgages or home equity lines of credit, likely increasing their cost of borrowing.
Concerned homeowners who have the option of converting to fixed-rate loans may want to consider doing so, USC’s Harris said.
The impact on fixed rate mortgages – including the popular 30-year fixed loan – is less certain.
Mortgage experts have said that increases in the fed funds rate do not directly affect these mortgages, but they can indirectly push fixed mortgage rates up or down if Fed actions influence investors’ thinking on the entrenchment of inflation.
This is because if inflation is expected to be high in the future, investors will demand a higher yield or interest rate on mortgages before buying them.
Already, mortgage rates have jumped this year, from 3% in January to over 5% last week, and by some measures are now above 6%.
The sharp rise in borrowing costs has pushed some home buyers into new price ranges and pushed others out, causing home sales to plummet.
It’s possible that a larger-than-expected increase in the federal funds rate will convince investors that inflation will be brought under control sooner and thus drive down fixed-rate mortgages, said mortgage industry consultant David Stevens, who is also the former head of mortgage bankers. Assn.
Alternatively, larger Fed rate hikes could spook investors and push mortgage rates higher, said Keith Gumbinger, vice president of research firm HSH.com.
Credit card debt
Credit card interest rates are not set by the Fed, but they move with the federal funds rate. When this rate increases, credit card interest rates will also increase.
“With interest rates rising, people who have borrowed money at variable rates, like people who have borrowed with their credit cards, should make an extra effort to reduce their balance as quickly as possible” , said Harris of USC. “Otherwise they will pay higher rates in the future, which will hurt them.”
Labor market mobility
The Fed’s higher-than-expected rate hike means hiring will likely slow and there could be more layoffs on the horizon, UCLA’s Feler said. He predicts that the national unemployment rate will reach 4.5% by the end of the year, up from 3.6% currently. As unemployment rises, wage growth slows, which dampens consumer purchasing power.
This means people will worry about keeping their jobs and may be less likely to ask for higher salaries. Those in low-wage jobs or jobs they dislike will be more likely to stay in their current job for fear of being unemployed.
“The trade-off right now is that the Federal Reserve is willing to sacrifice some jobs in order to make sure that inflation goes down because in the long run if we continue to have inflation rates that high it really hurts consumers,” says Feler.
This comes at a time when hiring is booming. In May, the United States added nearly 400,000 jobs, with unemployment remaining low. Overall, businesses have been keen to hire to meet consumer demand for goods, although some sectors, especially those that have thrived during the pandemic, such as Peloton and Netflix, have seen cuts.
Less demand for goods
High inflation has reduced buyers’ purchasing power as price increases have absorbed any pandemic-related wage increases. But consumers don’t seem to have reduced their spending significantly yet. This means that it may take longer for Fed action to translate into a slowdown in consumer demand.
By playing with the interest rate, the Fed tries to influence demand in the economy. Higher interest rates lead to higher borrowing costs and discourage consumers and businesses from spending less.
Consumers stop buying goods because they fear losing their jobs. Discretionary spending like dining out or streaming services are reduced. Sales of furniture and appliances are slowing because prices from potential buyers are shut out of the market. Expensive item purchases are removed.
This means good news for your savings.
“It gets more people to save because you want to reward people who save or become savers,” UCLA’s Feler said. “What you’re trying to get people to do is not go out and consume as much as they used to consume.”
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