By now you know the Federal Reserve, the central bank in
the United States, has been hiking interest rates since March of 2022. This
markets the first time the Fed has raised rates since 2018. The Federal
Reserve's main objectives are to promote maximum employment and keep prices
stable. Generally, the aim for the central bank is to keep inflation around 2%
annually. It's main tool to affect inflation is interest rates. When the Fed
changes rates, they are setting the short-term borrowing rate for commercial
banks and those banks turn around and pass those rates along to consumers and
businesses. This change influences the interest we as consumers pay on credit
cards, mortgages, car loans.
Most reading this article probably know that the Fed
raising interest rates means everyone pays more to borrow on credit cards or
loans to buy large items like homes or cars. Consumers should also benefit by
seeing higher rates paid on savings accounts and money markets. But how else do
interest rate hikes affect us? Here are five areas to keep an eye on:
Stock Prices
Generally, there is no direct relationship between the
stock market and interest rates but the two have historically moved in opposite
directions. A move north in interest rates can mean less profitability for
companies, a key metric when investors look to invest in the stock of a
company. Companies that do significant international business can often be
impacted even more negatively because a rate hike usually brings strength to
the US dollar. As the US dollar rises against foreign currencies, companies can
see their sales abroad decline in real terms.
Bond Prices
While many investors often look to bonds to mitigate
volatility and offer safety for their portfolios interest rate hikes usually
send the price of bonds lower, bringing pain for the average fixed-income
investor. For 2022, this is playing out like the United States has never seen.
The pace of interest rate hikes is the fastest in decades, nearly twice as fast
as hikes in 1988-1989. This has led to the worst year ever for bonds in the
United States. Using the Bloomberg US Aggregate Index, going back to 1977 bonds
have fallen in value only five times and never more than 2.9% (1994). As of
this writing, the iShares Core US Aggregate Bond ETF (AGG) is down over 16%
since January 1, 2022.
Home Prices
Higher interest rates will often cool demand for home
purchases which affects the prices of those very homes. Higher mortgage rates
have caused a considerable pullback in mortgage applications. As of the
beginning of September, mortgage applications were down almost 30% year over
year. Less demand for purchases means prices come down.
Higher Taxes?
A rate hike isn't just a hike on interest for consumers.
This also boosts the borrowing costs for the US government. In 2022, the four
largest items on the US National Budget are Medicare/Medicaid, Social Security,
Defense/War, and Net Interest on Debt. Right now, the estimated total budget
deficit from 2022 to 2031 will be $12.7 trillion. Increasing rates by just .50%
would increase this deficit by over $1 trillion. How does the government get
out of this debt? They don't collect extra money by selling hamburgers and hot
dogs. The way the government takes in revenue is from taxes. Might there be an
administration that comes in and decides they want to fix the deficit problem
by significantly raising taxes? Perhaps.
Insurance Policies
It's not all bad! While existing permanent life insurance
policies like whole life or indexed universal life policies may be tied to old
rates, its possible the insurance company may respond by increasing their
dividend rates and/or crediting rates. Some carriers may pivot to new products
that come with much richer benefits. New purchases of life insurance contracts
will benefit from this, and legacy policyholders can take advantage of a
tax-free 1035 exchange to move into the newer, better policy.
https://www.investopedia.com/articles/investing/010616/impact-fed-interest-rate-hike.asp
https://www.weforum.org/agenda/2022/10/comparing-the-speed-of-u-s-interest-rate-hikes-1988-2022/
https://www.forbes.com/sites/qai/2022/09/22/is-this-the-worst-year-ever-for-bonds/?sh=15a9e3b72b4f
https://www.realtor.com/news/trends/will-home-prices-drop-what-to-expect-in-the-fall-housing-market/
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