The Federal Reserve Bank announced a 75-basis point interest rate hike on Wednesday, a 50 percent greater increase than the central bank had initially signaled it was going to make for June.
The move comes after inflation hit a new, 40-year high last week, with consumer prices reaching an 8.6 percent maintain over where they were a year ago.
Fed watchers predict that the bank’s benchmark Federal Funds rate will continue to rise throughout the year, perhaps at a quicker pace than originally expected if higher prices don’t go down.
Even with the rate hike, interest rates will still only be around 1.6 percent, close to all-time lows.
Here are five ways that an environment of increasing interest rates will affect Americans’ wallets and the economy:
Mortgage, car and credit card payments are going to increase
The Federal Funds rate sets the rate at which banks and credit unions can lend money to each other as they determine their need for capital to make investments across the economy.
Banks that borrow money at the Federal Funds rate then need to charge a comparable rate to the people and institutions that borrow money from them. So an increase in the Funds rate translates down to higher rates in credit markets, mortgage markets and any industry that relies on financing plans to make payments.
This means higher monthly house and car payments and a bigger price tag on outstanding credit card debt.
Mortgage rates are already seeing sharp increases. Interest payments for the US benchmark 30-year-fixed rate mortgage made the largest one-week jump in 35 years, hitting 5.78 percent as of Thursday, up more than half a percentage point since only the week before.
That means a mortgage payment on a median-valued $400,000 home, after a 20-percent down payment, would now be about $1,875 dollars. Last year, the monthly payment on the same home would have been $1,335. That’s more than a $500 dollar-a-month difference.
Stock markets are falling and seeing dramatic swings in prices
Those increased prices that consumers are paying mean that people tend to rein in their spending, which brings down the demand for goods and services. The consequence for companies is diminished earnings, which means investors become less willing to pay for ownership shares, and this causes stock prices to fall.
Since January, most major indices of US stocks have fallen around 20 percent, entering what’s known as a bear market, or an extended period of shrinking share prices.
The Dow Jones Industrial Average has fallen 18.6 percent this year, dipping below 30,000 on Thursday off a January high of 36,800. The S&P 500 index has dropped beneath 3,700 off a high of 4,800, a decline of more than 22 percent, over the same period.
The technology-heavy Nasdaq, whose companies tend to hold extra debt making them particularly sensitive to interest rate increases, has fallen by more than 30 percent.
Since March, when the Fed first started raising interest rates with a modest 25 to 50-basis point target range, the Dow has fallen 12 percent, the S&P has fallen 16 percent, and the Nasdaq has fallen 20 percent.
It’s going to be harder to find a job
Price increases that shrink demand also have the effect of forcing companies to cut costs, and one of the first places they look to do that is in the labor force.
The housing market provides a clear example of this process, according to Desmond Lachman, an economist with the American Enterprise Institute (AEI), a right-leaning Washington think tank.
Mortgage rates that “used to be a little bit over 3 percent at the start of the year are now around about 6 percent. That means people who could afford a $100 house at the start of the year can only afford a house now around $70. That means there’s a whole lot less demand for houses, so house prices begin leveling and coming down, and so builders don’t want to build so many houses, and then people aren’t employed,” Lachman said in an interview with The Hill .
While this may sound like a bad thing, it has positive longer term effects for the economy, which has been experiencing some of the highest employment levels in decades, with around 96.4 percent of job seekers currently employed and 11.4 million jobs currently open, according to the Department of Labor.
Having a looser labor market means companies don’t have to keep charging higher prices in order to turn a profit for their investors, and this can drive down inflation and stretch the value of a dollar.
So even though higher rates will mean an end to the nominal wage gains that have benefited workers during a period of labor scarcity, the increased purchasing power of the dollar should add real value to paychecks.
The likelihood of a recession is growing
While the Fed has been Pursuing a “soft landing” for the economy – lowering inflation toward 2 percent without triggering a recession – many market commentators are viewing recession in the next year or two as increasingly likely.
“I’m not as worried about a return to the inflation levels of the 1970s as I am about a deep recession that is going to bring inflation way down soon,” AEI’s Lachman said.
The fears of a serious recession, or the combination of slowed growth and weakly valued money known as “stagflation,” are compounded now by geopolitical issues that extend beyond the reach of the monetary policy levers held by the Fed.
These include the war in Ukraine, which has had an effect on global food prices, as well as lockdowns in China, which have affected production pipelines. Broader issues with supply chains, which have been stymied by sky-high energy prices and congestion at ports, are also powerful forces dragging on the global economy.
A recession for Americans following interest rate hikes will be a double-edged sword. While it will bring down prices in the medium-term, it will also mean a period of reduced economic activity. This will translate into lesser returns on investments in the stock market and other securities markets, worse performance in retirement plans like 401Ks and lower nominal wages.
The national deficit is going to cost (taxpayers) more
With interest rates at or near zero, economists tend not to worry about the federal deficit, the value of which stands now at about a year and a quarter’s worth of productive output, or gross domestic product (GDP).
The resounding economic recovery experienced by the US economy after the near-total shutdown of the private sector due to the pandemic took a bite out of the US national debt. The latest projection of the deficit from the Congressional Budget Office was $1.7 trillion lower than expected.
But with interest rates on the rise, pleasant surprises like this one will be fewer and farther between, as paying off the national debt will require more taxpayer money.
“The government is going to have to pay out more in interest payments,” Lachman said. “On top of that, what’s going to happen in the progress that we’ve been making in reducing the deficit is also going to go, because as the economy tanks and goes into recession, it means the government’s going to collect fewer taxes.”
Lachman added: “The wrong thing for the Fed to do was – especially after the Biden package of $1.9 trillion, 8 percent of GDP, the kind of fiscal stimulus that we’ve never had before during peacetime – the Fed just sat with interest rates at zero and then kept convincing itself that inflation was transient and had nothing to do with the fact that the money supply had increased by 40 percent over two years. That was insane.”