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How the Federal Reserve Impacts You

The Federal Reserve, the nation’s central bank, took steps in July to curb inflation by raising the target range of the federal funds rate by 25 basis points from 5.25% to 5.50%. Consumers may be left wondering how this effort controls inflation and what its impact may be on their own personal finances going forward.

While the idea of inflation may seem scary to most consumers, what many don’t know is the function of these hikes and how they can actually benefit the economy and you in the process.

What Are Federal Reserve Hikes and Who Makes Them?

shooting down inflation

The Federal Open Market Committee (FMOC) is the governing body of the central bank of the United States, otherwise known as the Federal Reserve. This committee meets eight or more times a year to review current market conditions, set new monetary policies and adjust the target federal funds rate as needed.

The federal funds rate is the interest rate that commercial banks and financial institutions charge each other when they lend or borrow eligible reserves. While the FMOC doesn’t set the actual rate, it does establish a target range with an upper and lower limit.

  • The upper limit represents the interest on reserve balances, which is the interest that banks get on deposits kept at the Federal Reserve.
  • The lower limit represents overnight reverse repurchases, which are securities that the Federal Reserve lends to banks.

As the Federal Reserve determines the upper and lower ranges of the target, the federal funds rate, in turn, tracks within it. It can be confusing, but what’s important to know is that these rates help regulate the supply and flow of money within banking institutions and with consumers across the country.

Relationship Between Inflation and Federal Reserve Hikes

The Fed uses its ability to set the target for the federal funds rate as a tool to control inflation. At its most basic level, inflation is simply the rise in the cost of goods because more money is available. Goods and services become more expensive because more people want those goods and services and are willing to find ways to pay for them.

Ideally, long-term inflation remains around 2 percent. However, in 2021, the annual inflation rate shot to 7 percent and remained at 6.5 percent for 2022. In turn, the Fed began steadily hiking interest rates to slow down spending. As of the first half of 2023, annual inflation is down to 3 percent.

Fed rate hikes reduce the amount of money available, and come with some advantages. These hikes make saving money more lucrative and they also allow those who owe money to pay back at a price that is less than the new value of the item borrowed. This means that doubling down on savings or knocking out debt during this time can be even more beneficial to you financially.

Effects of Federal Reserve Hikes on Borrowing Costs

Since Fed hikes increase the amount of interest banks charge for borrowing, lending institutions pass on those increases. New loans and refinanced loans will carry higher rates than before the Fed rate hikes. La Cap lending products are competitive in all market conditions.

Impact of Fed Hikes on Savings and Investments

The good news is that Fed rate hikes offer a huge benefit for savers (as well as those paying down older debts). Financial institutions use the federal funds rate as a reference for what they will pay their own depositors. Accounts with variable annual percentage yields will respond more quickly, but consumers may also have new, more advantageous opportunities to save or invest in higher-yield financial products.

  • Bonds respond to higher interest rates favorably, with the price decreasing but the yield increasing. In fact, longer-term bonds let you lock in yields for the term. For example, the yield for 10-year US Treasury notes rose from 1.52 percent at 2021’s end to 4 percent by mid-July 2023.
  • Interest rate hikes can have a negative effect on earnings and stock prices. Stocks prices typically decrease when the Fed increases interest rates, but current conditions are not typical. Investor’s Business Daily noted that U.S. stock market gains in the first half of 2023 have been rosier than some years in the past. The S&P 500's rise in 2023 reached almost 16% in mid-June. That surpassed full-year gains in 2010 (up 15.1%), 2011 (2.1%), 2014 (13.7%), 2015 (1.4%) and 2016 (12%).
  • Retirement accounts like 401(k)s can respond to Fed rate hikes in a number of ways. A lot depends on how funds are distributed. An account for someone just starting their career may be invested more heavily in stocks that are considered higher risk but offer high yields in bullish times. An account for someone planning to retire has usually been transitioned to lower-risk investments that may respond more favorably to interest rate increases. The challenge is whether the increases in yield can keep pace with rates of inflation.

Consumer Spending Following Fed Hikes

The Federal Reserve’s goal in raising interest rates is to gradually control inflation by cooling the economy without throwing the country into a recession. When the cost to borrow money is cheap, people borrow and continue to buy, and prices continue to increase with demand.

When the cost to borrow money becomes more expensive—higher interest rates, for example—people tend to hesitate and borrow only what’s necessary because higher interest rates cut into how much house, car or goods and services they can afford. The $300,000 mortgage that would have cost them around $1,300 a month went to just under $2,000—which may or may not be within their financial means.

Strategies Related to Federal Reserve Rate Hikes

  • Make sure savings are in accounts with high yields. Interest rate hikes mean that money market accounts, certificates of deposit and IRAs, for example, offer potentially increased earnings.
  • Monitor retirement accounts and periodically evaluate allocations across funds to take advantage of higher interest rates in investments appropriate for your life stage.
  • If you’re considering a mortgage, key points for analysis are how much house your current monthly rent will buy, whether you can save up a 20-percent down payment and whether you can buy with less or even zero down so that you can hold on to your cash. Then, consider terms and interest rates carefully. A fixed-rate mortgage will keep your interest rate the same for the life of the loan, while an ARM — adjustable-rate mortgage — will periodically shift with the market throughout the life of the loan.
  • Take advantage of one-time bump certificates to grow your savings with greater returns during higher inflation periods. In fact, you can get 5.15% APY for 16 months or 5.25% APY for 26 months on a La Capitol Bump Rate Share Certificate for a limited time. These accounts are designed to guarantee the starting rate of your savings, and they offer a one-time bump if interest rates rise during the term of the certificate.

Make Inflation Work for You Financially

Most importantly, follow what the Fed is doing because it really does affect your financial options, and be sure to choose a financial institution that has your best interests at heart. In Louisiana, that would be La Capitol Federal Credit Union. We offer competitive rates for mortgages and loans, great ways to save, and credit card options made for your lifestyle. Check us out, and see why so many in Louisiana make their financial decisions with La Cap.

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