Fed's trying to halt inflation with big rate hikes. How this affects debt, stocks, savings
- The Fed raised its benchmark interest rate again this month by 75 basis points.
- More rate hikes are expected, too, this year as the Fed battles surging inflation.
- Consumers should prepare by locking in fixed rates, refinancing, and paying off high interest debt.
Investors should expect those higher costs to head even higher.
The Fed's policymaking committee on Wednesday raised its benchmark short-term fed funds rate by 75 basis points, as expected, after 12-month June consumer inflation accelerated to a 9.1% pace from 8.6% in May. The move brings the fed funds target range to 2.25% and 2.5%.
Last month, the Fed also raised rates by 75 basis points, which was the largest one-time increase since 1994, to a range of 1.5% to 1.75%.
Although the Fed doesn’t directly control consumer interest rates, its rate increases ripple through the economy and ultimately, hit businesses and consumers and slow demand and inflation.
“Two three-quarter percentage point hikes in a row – with more rate hikes still to come – mean a summer of discontent for borrowers with credit card debt, home equity lines of credit, or other variable rate debts that will see rates rising in big chunks over a short period of time," Greg McBride, Bankrate chief financial analyst, said.
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How high will interest rates go?
The Fed is generally expected to increase rates at every meeting for the rest of this year to get inflation closer to its 2% target.
The hikes, though, may get smaller. ING chief international economist James Knightley expects only 50-basis-point increases in September and November with a final quarter point in December.
Deutsche Bank economists also see a downshift to 50 basis points in September, but said risks are weighted towards a 75-basis-point increase with only two inflation releases slated between the July and September meetings to gauge improvement in inflation trends.
How does this affect my plans to buy a house?
Homeowners with existing fixed-rate mortgages won’t see any changes. But recent and prospective homebuyers are being socked by higher rates that take into account projected Fed increases through much of 2022.
Rates are at a more than 10-year high: June 2009 was the last time the average 30-year, fixed mortgage rate was at or above 5.50%, according to LendingTree.
“The housing market is incredibly rate-sensitive, so as mortgage rates increase suddenly, demand again is pulling back,” Sam Khater, Freddie Mac chief economist, said.
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Demand for mortgages and refinances hit a 22-year low last week, Mortgage Bankers Association said.
To put into perspective just how much rising rates can impact borrowers getting a new loan, consider that the average 30-year, fixed mortgage rate on December 30 was 3.11%, 2.43 percentage points lower than the latest average of 5.54% on July 21. On a $300,000 loan, a rate of 3.11% results in a monthly payment of about $1,283, Jacob Channel, senior economist at LendingTree, said.
That same $300,000 loan with a rate of 5.54% results in a monthly payment of $1,711. That’s an extra $428 a month, an extra $5,136 a year, and an extra $154,080 over the 30-year lifetime of the loan, he said.
How do higher interest rates affect the stock market?
Usually, technology and growth stocks are hardest hit by rising interest rates because they rely more on borrowing to fuel their growth.
But with the dual fear of higher rates and recession (or stagflation), more sectors are getting hit this time around. The S&P 500 officially fell earlier this summer into a bear market, which means the index is down at least 20% from its record high in January.
This prompted investors to buy stocks of companies that make or sell things people must buy, like energy and consumer staples, no matter how the economy fares.
But a recent uptrend in stocks has brought the stock market off its lows and major indices closed higher for two weeks in a row on Friday. Some of that optimism stemmed from better-than-expected forecasts from major companies, but market watchers continue to warn that the economy remains anxious.
"Every day we are getting headlines about the biggest and best-run companies slowing hiring," Mike O'Rourke, JonesTrading chief market strategist, said. "The only companies to meaningfully rave about business are the airlines, but they keep missing earnings estimates. In this new market regime that severely lacks visibility, we suspect chasing backward-looking earnings will prove to be a mistake."
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How do Fed rate hikes affect credit cards?
Credit card interest rates are notoriously among the highest ones you'll pay with annual percentage rates already near record highs, but they're going even higher. That means your debt is going to keep getting more expensive this year unless you act now.
You should immediately start shopping for a new credit card that offers a lower rate, experts say.
"These Fed rate hikes don’t just raise APRs on new credit cards," Matt Schulz, LendingTree chief credit analyst. "The rate you pay on your current balances goes up, too, usually within a billing cycle or two. Any rate increase is unwelcome, but given that we've already seen three this year and there's almost certainly more to come, it should serve as a wake-up call for consumers."
Other steps you can take include taking advantage of 0% transfer offers for another card and start paying down the principal right away. Just make sure not to add debt to that card and make your payments.
You also can call your card issuer to request a lower rate on your cards.
"Far too few people do it, but 70% of those who did in the past year saw at least some reduction," Schulz said.
How do Fed rate hikes affect auto loans?
A Fed rate increase Wednesday should make its way to new auto loans, but the toll should be less painful. Typically, the cost of a quarter-point increase in rates on a $25,000 loan is just a few dollars extra per month, experts say.
How does Fed's decision affect bank savings interest rates?
As Fed rates rise, banks will be able to charge a little more for loans, giving them more profit margin to pay a higher rate on customer deposits.
"However, savings account and short-term CD rates will likely rise more than long-term CD rates until there is little if any rate advantage with long-term CDs." Ken Tumin, founder of DepositAccounts.com, said. "This is a condition that already exists with Treasury yields."
That condition is called the "inverted yield curve," which signals that the market expects short-term rates to rise sharply relative to long-term rates. It is also seen as a sign a recession is imminent.
If investors are looking to collect as much yield as they can on their savings, look online. Online rates as of May 1 ranged from 0.54% at the low for a savings account to as high as 2.89% for a 5-year CD. That contrasts with brick-and-mortar rates of 0.13% to 1.03%, respectively.
Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at firstname.lastname@example.org and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.
Paul Davidson is USA TODAY's senior economics correspondent. You can follow him on Twitter @PDavidsonusat.