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:
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.
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.
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.
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.
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.