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Federal Reserve Interest Rate Hikes

Last updated 03/14/2024 by

Benjamin Locke

Edited by

Fact checked by

Summary:
When the Federal Reserve raises its base rate, the immediate goal is to slow down the economy, mostly to temper inflation. For investors, it can make debt much more expensive and slow down both the stock market and the real estate market. However, it can offer a better return for more conservative investors who like to keep their money in a bank or money market account. When the Federal Reserve raises rates, the reverberations are felt throughout countries across the globe.
From living rooms in small-town Mississippi to the glittering towers of Hong Kong, people will watch to see if the Federal Reserve is going to hike interest rates. When the Fed raises interest rates it has a profound effect on U.S. and global finances. For many Americans, it can result in families putting off buying a home for years or drastically increasing what they pay in credit card debt. However, those who save or invest will find that savings accounts, CDs, and money market accounts benefit greatly from a hike in federal interest rates.
When the Fed does raise rates, however, it results in a massive flow of global capital to the U.S., which can cause a significant knock-on effect for countries and their currencies around the world. Keep reading to learn more about Federal Reserve interest rate hikes.

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Why does the Fed raise interest rates?

The Federal Reserve is America’s central bank. Like any other central bank, the Fed’s job is to ensure the economy operates in a stable fashion, people are employed, and prices only increase incrementally. In classical economics, a base interest rate can be used to encourage investment in an economy that needs reviving or slow down interest rates in an overheating economy. In most cases, the Fed has used interest rates to combat inflation as classical economic theory dictates. The Fed will have a target range for inflation, and Fed officials will manipulate the interest rate by a quarter point or more accordingly. The graph below shows how the Fed has manipulated its average rate since 1955.
The graph shows the Federal Reserve’s base rate since 1955, not so long after World War 2. You will notice that although the rate hikes in the 2020s are significantly higher compared to the low-interest rates and cheap money available before, they are nothing compared to some of the rate hikes that occurred in the 1970s and ’80s.

2008-2020 was an aberration

It’s important to note that in the grand scheme of things, the period between 2008-2020, in which interest rates hovered around 0%, was a complete aberration. Never had interest rates been so low and money that cheap for so long. Many economists argue that this fueled an addiction to cheap money, and we are feeling the consequences today.

Recent federal rate hikes

The chart provided below shows the specific dates of meetings held by the Federal Reserve, in which the Federal Open Market Committee (FOMC) decided to alter interest rates. Each adjustment in the rate is detailed in terms of ‘basis points’, often abbreviated to ‘bps’. The new target range for the federal funds rate, resulting from these changes, is also mentioned.
To clarify, ‘basis points’ is a standard term used to denote changes in interest rates. One basis point represents a change of 0.01% or 0.0001 in decimal form. So, if an interest rate were to shift by half a percentage point, that would translate to a movement of 50 basis points.

What does a Fed rate hike mean for me?

When the Fed sets its rate, it is effectively telling banks the interest rate at which they can borrow money. Many people are affected when the Federal Reserve raises interest rates in the United States. Just ask Bob Chitrathorn, CFO and vice president of Simplified Wealth Management.
“I can say that the Fed raising interest rates has hurt many clients because of what it portrays to them and to the rest of the population,” he says. “It’s more of an emotional, and/or potential psychological thing. It seems to make people think that inflation is going to continue to go ‘crazy’ and that raising rates actually makes inflation worse. Most just aren’t fully informed on how things work in regard to inflation and interest rates and the ways that the feds try to curb inflation.”
Below are some of the consequences of the Federal Reserve raising interest rates.

Mortgages are more expensive and the property market might decline

When the Federal Reserve charges more for banks to borrow money, they pass on that cost to the end consumer who takes out a loan. Therefore, mortgage interest payments become much more expensive. Here we can see a graph of mortgage rates since 1971. You can see that rates were raised significantly in the 1970s and 1980s, only to trend downward until 2020 and up again more recently.
Megan Kelly, a financial advisor at Goodcheddar.com, says that some of her clients with other financial products that carry variable rates cannot bear such crazy cost increases. “With the recent raising of interest rates, many have felt the impact in terms of the cost of borrowing,” she says. “From mortgages to home equity and credit lines, the increases are unprecedented. Perhaps those with a variable rate may have noticed the most.”
Higher mortgage interest rates mean not as many people can afford a property. For example, a $400,000 property with a 30-year mortgage at 3% interest can go from a $1686 monthly payment to a $2,660 monthly payment when the interest rate jumps to 7%.
There are many other factors at play, including inventory, but in most cases, this means that property prices will go through a period of decline.

Pro Tip

The introduction of permanent capital into the U.S. property market has slightly warped the effect of rising interest rates. Large funds and institutional investors can afford to close in cash immediately and are taking an ever-increasing share of the residential property market in the U.S. The same could be said for the preference for multi-family development or build-to-rent properties. In fact, according to Hunter Housing Economics, build-to-rent homes make up more than 6% of the new housing stock annually on average. And it’s set to double to 12% by 2024.

Savings accounts, CDs, and money market accounts give great returns

Just as it costs more to borrow money from banks and financial institutions, higher interest rates can help savers earn more money at their preferred bank or financial institution. You will typically see a significant increase in returns on savings accounts, money market accounts, and certificates of deposits (CDs).
This also means that since the returns are higher for safe-haven deposit vehicles, such as CDs, savings accounts, and money market accounts, the appetite for risk declines. Why take on risk when you can earn a good return in a much safer environment?

The stock market could decline

Remember, the Fed is trying to slow down economic growth by making it more expensive for companies to borrow. Obviously, making it more expensive for companies to borrow can impede their growth. Furthermore, it makes it more expensive for financial entities to borrow money, which may include investing in the stock market.
Either way, the Federal Reserve raising interest rates can have a negative effect on the stock market. This shouldn’t be surprising, though, as the goal of the Fed’s interest rate hike is to slow down the economy. The stock market and the economy go hand and hand, and thus, one is bound to affect the other.

Bond prices fall when new bonds with better yields are issued

In general, when interest rates rise, bond prices decline. When interest rates go lower, bond prices increase. Why do they decline when interest rates rise? The answer to this question has to do with new bonds vs. old bonds. For instance, say you bought a treasury bond that pays you a 2% interest rate five years ago. As you bought it five years ago, you still have five years of 2% interest to go.
If the Fed raises interest rates, that means that newly issued bonds will pay a higher interest rate than the ones you bought. For example, now, people can buy newly issued Fed bonds that pay 4% or 5% interest for a full 10 years. Why would they buy your bond that pays a measly 2% for five more years when they can get a full 10-year treasury bond paying them 5%?

Credit cards and loans are more expensive

Just like mortgages get more expensive with a Fed rate hike, so do most loans and credit card debts. Whether it be a personal or business loan, as it’s more expensive for the lender to borrow money from the Fed, it’s more expensive for the end consumer. A hike can also impact federal student loans.
As credit cards already charge a higher interest rate than other loans, a Fed rate hike can affect credit card interest rates. Interest will start to encompass more and more of the required monthly payments.
If you’re thinking about taking out a loan, be sure to compare your options so you get the best interest rate possible.

SuperMoney may receive compensation from some or all of the companies featured, and the order of results are influenced by advertising bids, with exception for mortgage and home lending related products. Learn more

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The Fed’s rate hike impact on developing countries

A rate hike by the Fed can spell doom for certain developing countries that might be on shaky ground economically. Here is why.

Capital flight

When the Federal Reserve raises interest rates, it can cause a flight of capital out of emerging markets into safe-haven assets in the U.S. that are now producing a high yield. Remember, risk and return usually correlate; therefore, if people can achieve a high return from a less risky asset such as treasury bonds or a money market account, they will choose those.

Debt service costs

If a country has debt that is priced in U.S. dollars and in which the interest rate is in flux, it can cost significantly more to service that debt. This can drive countries toward having to make hard decisions about allocating their budget, or they risk default.

Currency devaluation

When the Fed raises its base interest rate, the dollar becomes more attractive and stronger as an investment vehicle. This causes devaluations for the currency in many emerging markets as compared to the dollar. This means anything imported or priced in dollars (oil, commodities) will become more expensive.

A decline in commodity prices

Many emerging markets are highly reliant on commodity and natural resource exports. With higher interest rates and a stronger U.S. dollar, commodity prices can go down. Again, if you look at it from a bird’s eye view, for some countries, income (commodity prices) declines while debt servicing increases with the federal funds rate.

FAQ

How much will the Fed raise interest rates?

The Fed will raise interest rates in response to the economy and inflation. They want to tame inflation but not suppress wage growth, and thus it’s a delicate balancing act. Typically, the Fed will only raise rates by .25% at a time, but if inflation is bad enough, it could be .5% or more.

Did the Federal Reserve hike interest rates?

The Federal Reserve has been hiking interest rates since 2021. They will continue to do so if they feel that inflation is spiraling out of control and not within their target range.

What is the Fed interest rate today?

The Fed rate is between 4.75-5% at the time of this writing in 2023.

Key takeaways

  • When the Federal Reserve raises its base rate, the immediate goal is to slow down the economy, mostly to temper inflation.
  • A hike in interest rates can make loan and credit card debt more expensive. In many cases, it can result in a decline in the property market, stock market, and bond market.
  • For safe-haven assets such as CDs, savings accounts, and money market accounts, a hike in the Fed’s base rate will result in stronger yields and returns.
  • A hike in the Fed rate can cause profound consequences for emerging markets for a myriad of reasons, such as capital flight and expensive debt servicing.

SuperMoney may receive compensation from some or all of the companies featured, and the order of results are influenced by advertising bids, with exception for mortgage and home lending related products. Learn more

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