This is how an increase in Fed rates can affect you

(CNN Business) – The Federal Reserve is redoubling its efforts to fight inflation. This means that borrowing costs will be higher for businesses and families.

Fed officials raised the benchmark interest rate by three-quarters of a percentage point on Wednesday, the largest move since 1994.

The move follows the Federal Reserve’s decision to raise interest rates by half a percentage point in May, the most significant rate hike in 22 years.

The fact that the Fed is finally moving away from zero interest rates shows confidence in the health of the labor market. But the speed with which interest rates are expected to rise underscores his concern about the rising cost of living.

High inflation, with consumer prices rising in May at the fastest pace in 40 years, is likely to force the Fed to raise interest rates several times in the coming months.

Americans will experience this change in policy with higher borrowing costs: getting a mortgage or a car loan won’t be very cheap. And the cash deposited in bank accounts will eventually earn some interest, though not much.

The Fed speeds up or slows down the economy by raising or lowering interest rates. When the pandemic hit, the Fed made borrowing almost free in an effort to encourage household and business spending. To further boost the economy devastated by the Covid-19 virus, the US central bank has also printed trillions of dollars through a stimulus program called quantitative easing, otherwise known as quantitative easing. And when credit markets froze in March 2020, the Fed set up an emergency credit facility to prevent a financial meltdown.

The Fed bailout succeeded. There was no financial crisis due to the Corona virus. Vaccines and massive spending by Congress paved the way for a quick recovery. However, his emergency measures, and delays in withdrawing them, also contributed to the overheating of the current economy.

Today, unemployment is at its lowest level in the last 50 years, but inflation is very high. The US economy no longer needs all the help from the Federal Reserve, so it is slowing down the economy by raising interest rates. The danger is that the Fed acts too much and slows the economy too far, leading to a recession that leads to layoffs and unemployment.

Borrowing costs are rising

Every time the Federal Reserve raises interest rates, it becomes more expensive to borrow. This translates to increased interest costs on mortgages, home equity lines of credit, credit cards, student debt and auto loans. Corporate loans will also become more expensive, both large and small.

The most tangible way for this to happen is through a mortgage, where expectations of higher interest rates have already affected mortgage rates.

The average 30-year mortgage rate was 5.23% in the week ended June 9. This number is significantly higher than the same period last year, when it was 3%.

Higher mortgage interest rates will make it more difficult to access a home as prices rise during the pandemic. Lower demand can lower prices.

The median price of an existing home sold in April rose 15% year-over-year to $391,200, according to the National Association of Realtors.

How much will interest rates rise?

Investors expect the Fed to raise the upper end of the target range to at least 3.75% by the end of the year, from 1% today.

For context, the Fed raised rates to 2.37% during the height of the last rate-raising cycle in late 2018. Prior to the Great Recession of 2007-2009, Fed rates were as high as 5.25%.

In the 1980s, the Federal Reserve, led by Paul Volcker, raised interest rates to unprecedented levels to fight hyperinflation. At its peak, in July 1981, the effective federal funds rate exceeded 22%. (Borrowing costs will now not approach those levels, and there is little expectation that they will rise sharply.)

However, the impact of borrowing costs in the coming months will primarily depend on the pace of Fed rate hikes, which remains undetermined.

Good news for savers

Low interest rates have punished savers. Money in savings, CDs, and money market savings accounts generated almost nothing during the COVID pandemic (and for a good portion of the past 14 years, in fact). Compared to inflation, savers have lost money.

But the good news is that these savings rates will rise as the Federal Reserve raises interest rates. Savers will start earning interest again.

But this takes time to happen. In many cases, especially in traditional accounts at large banks, the effect will not be felt overnight.

And even after several price hikes, interest rates on savings accounts will still be very low, below the inflation rates and expected returns in the stock market.

Markets must adapt

Free money from the Federal Reserve has been great for the stock market.

Zero interest rates drive down government bond prices, essentially forcing investors to bet on risky assets like stocks. (Wall Street even has an expression for this: TINA, which means “there is no alternative.”)

Raising prices can also be a challenge for the stock market, which is accustomed – if not addicted – to easy money. Markets have already seen significant volatility amid concerns about the Fed’s plan to fight inflation.

But a lot will depend on how quickly the Fed raises interest rates, and how the underlying economy and corporate profits perform after doing so.

At a minimum, the price increase means that the stock market will face increased competition from boring government bonds in the future.

Low inflation?

The goal of the Fed’s interest rate increase is to control inflation, without affecting the labor market recovery.

Consumer prices rose 8.6% in May from a year earlier, the fastest pace since December 1981. Inflation was nowhere near the Fed’s 2% target and has worsened in recent months.

Economists warn that inflation could worsen as oil prices continue to break records in recent days, compounding the uncertainty since the Russian invasion of Ukraine. Everything from food and energy to minerals is becoming more and more expensive.

The rising cost of living is causing financial hardship for millions of Americans and contributing significantly to a decline in consumer confidence that is at its worst in a decade, not to mention President Joe Biden’s low approval ratings.

However, it will take time for the Fed to raise interest rates to start lowering inflation. Until then, inflation will remain subject to developments with the war in Ukraine, supply chain issues and, of course, Covid-19.

CNN’s Kate Traficant contributed to this report.

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