Did you buy a home in 2020? Did you job-hop in 2021? Did you hold off on buying a new car or home in 2022 until you can find a cheaper deal and lower interest rate?
Believe it or not, one institution impacts even the tiniest of your financial decisions: The Federal Reserve.
The Federal Reserve is the central bank of the U.S., one of the most complex institutions in the world. The Fed is best known as the orchestrator of the world’s largest economy, determining how much it costs businesses and consumers to borrow money. Cheap borrowing costs can be the difference between businesses choosing to hire new workers or make new investments. Expensive rates, however, can cause both businesses and consumers to pull back on big-ticket purchases — as well as hiring.
“Your job security, your portfolio, your debts and the direction of the economy are all subject to the Fed’s influence,” says Greg McBride, CFA, Bankrate chief financial analyst. “As that price of money changes, it ripples out in a lot of different directions. It impacts the health of the job market, the amount of money that’s flowing in the economy and the prices of assets at the household level.”
Here are the five main ways the Fed impacts your money, from your savings and investments, to your buying power and your job security.
Higher Fed interest rates translate to more expensive borrowing costs to finance everything from a car and a home to your purchases on a credit card. That’s because key borrowing rate benchmarks that influence some of the most popular loan products — the prime rate and the Secured Overnight Financing Rate, or SOFR — follow the Fed’s moves in lockstep.
When interest rates are higher, the availability of money in the financial system also tends to shrink, another factor making it more expensive to borrow. Sometimes, rates even rise on the mere expectation the Fed is going to hike rates.
Case in point, here’s how much more expensive it’s gotten to finance various big-ticket items this year, after 4.25 percentage points worth of tightening from the Fed:
Product
Week ending July 21, 2021
Week ending Jan. 25, 2023
Percentage point change
30-year fixed-rate mortgage
3.04 percent
6.42 percent
+3.38 percentage points
$30k home equity line of credit (HELOC)
4.24 percent
7.77 percent
+3.53 percentage points
Home equity loans
5.33 percent
7.65 percent
+2.32 percentage points
Credit card
16.16 percent
19.93 percent
+3.77 percentage points
Four-year used car loan
4.8 percent
6.83 percent
+2.03 percentage points
Five-year new car loan
4.18 percent
6.18 percent
+2 percentage points
Source: Bankrate national survey data
After holding above 7 percent for three consecutive weeks, the average 30-year fixed-rate mortgage dipped to 6.74 percent by the end of 2022. The more than 3 percentage point jump in a single year is unprecedented, McBride says.
Credit card rates, meanwhile, jumped to a record high of 19.04 percent on Nov. 9, 2022. They’ve ratcheted even higher with every Fed rate hike.
Consumers often see higher rates reflected in one to two billing cycles — but only if they have a variable-rate loan. If you pay off your credit card balance in full each month, higher interest rates won’t impact you.
Rates, however, climb at an even faster rate for borrowers perceived to be riskier, based on their credit history and score. Conversely, some lenders might offer better deals than others, simply to attract more customers in a competitive market.
“Borrowing costs tend to increase first after a Fed rate hike,” says Liz Ewing, chief financial officer of Marcus by Goldman Sachs. “Banks are not required to line up their interest rates with the Fed’s rate, so each bank will respond to the Fed’s rate announcement and adjust rates in their own way.”
And while mortgage rates generally follow the Fed, they can often — and quickly — become disjointed. Mortgage rates mainly track the 10-year Treasury yield, which is guided by the same macroeconomic forces. But at its most basic level, those yields rise and fall due to investor demand.
An inflation surprise helped send the 10-year Treasury yield surging past 4 percent last October, the highest since 2008. But on the flipside, two weaker-than-expected inflation reports have sent yields tumbling. The key borrowing yield is now 71 basis points below its peak.
Investors might pour more money into those safe-haven investments when the economy is expected to slow or contract, meaning mortgage rates might fall even if the Fed is raising interest rates. Longer-term yields, and consequently, mortgage rates, might also drop when the Fed is deep in the middle of an asset-purchase plan to lower longer-term rates, effectively making the U.S. central bank the biggest buyer in the marketplace.
You might not be able to borrow as cheaply as you used to before a Fed rate hike, but higher interest rates do have some silver linings, especially for savers: As banks turn more to consumer deposits to fund loans, they ultimately end up increasing yields to attract more cash.
The caveat, however, is yields hardly ever rise as fast or as high as the Fed’s interest rate. Traditional brick-and-mortar banks also hardly need the deposits, especially today.
The average savings yield has risen a full percentage point over the past year, rising from 0.06 percent to 0.23 percent as of Jan. 25, according to national Bankrate data.
Meanwhile, a 5-year certificate of deposit (CD) was paying an average 0.27 percent yield one year ago. Today, it’s offering an average of 1.17 percent.
But there are places where better payouts can be found, a search that’s becoming even more important for consumers amid high inflation. Those yields are at online banks, which are able to offer more competitive interest rates because they don’t have to fund the overhead costs that depository institutions with physical branches have.
A big example: The 14 banks ranked for Bankrate’s best high-yield savings accounts in July 2021 were offering an average yield of 0.51 percent, with a high of 0.55 percent and a low of 0.40 percent. At the time, that was about nine times the national average.
As of Jan. 26, the 12 banks ranked for January 2023 are offering an average yield of 3.99 percent, more than 17 times the national average. Those banks offer yields as high as 4.35 percent and as low as 3.64 percent.
“Retail savings rates often move a bit slower in a rising rate environment, but can also fall slower in a declining rate environment,” Marcus’ Ewing says. “Customers who have high-yield savings products could be getting good value in the long run.”
Cheap borrowing rates often bode well for investments because they incentivize risk-taking among investors trying to compensate for lackluster returns from bonds, fixed income and CDs.
On the other hand, markets have been known to choke on the prospect of higher rates. Part of that is by design: Essentially, the U.S. central bank zaps liquidity from the markets when it raises rates, leading to volatility as investors reshuffle their portfolios.
It’s also because of worries: When rates rise, market participants often become concerned that the Fed could get too aggressive, slowing down growth too much and perhaps tipping the economy into a recession. Those concerns battered stocks in 2022, with the S&P 500 posting the worst performance since 2008 in the year.
For those reasons, it’s important to keep a long-term mindset, avoid making any knee-jerk reactions and maintain your regular contributions to your retirement account. When the Fed raises rates, that’s mostly to make sure the financial system doesn’t derail itself by growing too fast.
“Low rates are like candy to investors and keeping rates low is like asking the Cookie Monster if there should be more cookies,” McBride says. “Mom-and-pop investors should focus on the bigger picture: An economy that’s growing is conducive to an environment where companies will grow their earnings, and ultimately, a growing economy and higher corporate earnings are good for stock prices. It just might not be a smooth road between here and there.”
The Fed’s interest rate decisions are bigger than just influencing the price you pay to borrow money and the amount you’re paid to save. All of those factors have a prevalent influence on the economy — and for consumers, that also means their purchasing power.
Low interest rates intended to stimulate the economy and juice up the job market can fuel demand so much that supply can’t keep up — exactly what happened in the aftermath of the coronavirus pandemic. All of that can lead to inflation.
But higher Fed interest rates are the fastest way to weigh on those price increases, though it’s important to point out that consumers won’t immediately feel an impact. The Fed can’t drill for oil or produce more food; all it can do is weigh on demand so much that it balances back out with supply, leading to a lower pace of price increases.
“We’re likely to feel the pain of a slower economy before we see the gain of lower inflation,” McBride says.
Inflation is already starting to cool, though Americans are paying more for the items they both want and need than they were before the pandemic. Cooling gas prices in December fell from a year ago for the first time since January 2021, while prices on common goods including used vehicles and electronics continued to drop, a Department of Labor report showed.
Yet, more improvement is needed. Groceries rose 11.8 percent, while rents surged the most on record. Services, including the price of dining out at a restaurant, getting a haircut or seeking medical care, are up 7.2 percent.
One of the biggest corners of the economy impacted by higher interest rates is the job market. Expansions that seemed wise when money was cheap might be put on the backburner. New opportunities made possible by low interest rates are no longer on the table. That has implications for more than just businesses. Individuals seeing new opportunities vanish might start to feel insecure about their positions; instead of job hopping to a new company, they might decide to stay put.
All of those moving parts are apparent now. Job openings are still at a near-record high but have cooled since the Fed started tightening borrowing costs, falling to 10.5 million in November from a record high of 11.9 million in March.
The unemployment rate is still at a near half-century low, but the question is how much longer that could last. Big tech firms Meta and Twitter have laid off thousands of workers; others, such as Apple, have said they’re freezing hiring. Economists see the unemployment rate climbing more than a full percentage point by December 2023, hitting 4.6 percent from its current half-century low of 3.5 percent, according to a Bankrate survey.
Revealing just how interconnected the economy is, sometimes a booming labor market can also contribute to inflation. When there’s a mismatch between labor demand and supply, companies often boost wages to recruit more workers. Fed Chair Jerome Powell described it as contributing to today’s stubbornly high inflation in a Nov. 30 address at a Brookings Institution event, estimating that almost 3.5 million workers are missing since the pandemic-induced recession began in February 2020.
Raising interest rates is a blunt instrument with no method of fine-tuning specific corners of the economy. It simply works by slowing demand overall — but the risk is that the U.S. central bank could do too much. Put in the mix that officials are trying to judge how rates impact the economy with backward-looking data, and the picture looks even darker.
Eight of the Fed’s past nine tightening cycles have ended in a recession, according to an analysis from Roberto Perli, head of global policy at Piper Sandler.
There’s a common mantra when it comes to the Fed: Don’t fight it. Most of the time, it means investors should adjust their decisions along with monetary policy.
Consumers, however, might want to take the opposite approach. A rising-rate environment makes prudent financial steps all the more important, especially having ample cash you can turn to in an emergency or taking a long-term perspective.
Boosting your credit score and paying off high-cost debt can also create more breathing room in your budget in a rising-rate environment. Use Bankrate’s tools to find the best auto loan or mortgage for you, and shop for the best savings account to park your cash.
“You need an emergency fund regardless of where interest rates and inflation are,” McBride says. “You can’t afford to take risks with that money. That’ll stabilize your financial foundation, in the event that tougher economic days lie ahead.”
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