Yesterday, the Federal Reserve Open Market Committee (FOMC) raised the federal funds target rate 50 basis points, or 0.50%. The main premise behind this big move is to try and cool down inflation that is running very hot lately. It makes money tighter, or, put another way, more expensive to get (borrow). How will this affect us as consumers as well as investors? Before we look at that, let’s review exactly what the Fed did.
The federal funds target rate is the rate banks charge each other when lending to one another. This is the basis that most rates that we are familiar with are calculated. For instance, the prime rate is the rate U.S. banks charge their best customers when lending to them. It is typically 3% plus the federal reserve funds rate, which is currently at 1%. So, the prime rate is now 4%. This is the foundation for mortgage rates, car loans, credit card rates, student loans, etc. Now that we know what was changed, let’s look at how it will affect us as both consumers and investors.
As consumers, borrowing money is going to cost more, plain and simple. Any type of loan with a variable rate, such as a variable rate mortgage, home equity line of credit, credit card, etc., has already gone up as of today. Any new loans will have a higher rate than if you took it out last week.
For savers, money market, bank savings accounts, and CD rates will go up, but unfortunately, not as much or as quickly. Well, anything is better than the 0.01% that I have been getting in my money market for the past 13 years!
For investors, it provides an alternative, i.e., bonds, for equity investors (stock market investors) to park their money and still get a decent return. Before this past six months, rates were so low since the great financial crisis that there was no place to go to but the stock market if you wanted a good return on your investment. Now, with the 10-year U.S. Treasury note paying about 3%, investors can at least get paid to wait before jumping back into stocks.
The Fed has a tough job on their hands: they have to tame inflation without pushing the economy into a recession. They already signaled that they will be bumping the fed funds rate higher throughout this year. They just have to monitor economic indicators vigilantly, so they don’t go too far. Good luck to them.
Please let me know if you have any questions.
Joe Baker, CFP®
Baker Asset Management, LLC
joebaker@bakerassetmanagement.com
