Fed likely to raise interest rates: Here’s how it might affect you
The Federal Reserve is set to hike interest rates for the first time since slashing them to near zero levels amid the onset of the pandemic two years ago.
The Federal Open Market Committee, the panel of Fed officials in charge of the central bank’s monetary policy, is almost certain to announce an increase to the federal funds rate, its baseline interest rate range, at the end of its meeting Wednesday. The range was set between zero and 0.25 percent in March 2020 to stimulate the economy with low borrowing costs.
Two years later, the U.S. economy has recovered rapidly from the quickest collapse in modern history, but at the cost of high inflation. The central bank is hoping to cool off rising inflation without denting several months of strong job growth.
Here’s how Fed rate hikes are likely to affect the economy and your life.
Higher borrowing costs for consumers
The Fed’s primary tool for slowing and stimulating the economy is adjusting the federal funds rate, an interest rate range the Fed sets for loans between banks. Banks also use the federal funds rate as a baseline for setting interest rates on the loans they offer to customers.
As banks face higher borrowing costs, they compensate by raising interest rates paid by their customers. Interest rates for credit cards, home equity lines of credit, automobile loans and other loan products are often set by taking the federal funds rate, adding several percentage points and adjusting for a borrower’s credit history.
“All of the short-term rates are still more or less glued to the federal funds. They adjust only when the Fed funds rate adjusts, so that will feed through,” said Brian Bethune, an economics professor at Boston College.
The Fed is likely to raise its baseline interest rate range by 0.25 percentage points Wednesday, so borrowers will not notice a major increase in their borrowing costs right away. The bank is expected to hike rates several more times this year, though Bethune said the Fed would go as gradually as possible to limit the disruption.
That means if you have a credit card, auto loan or line of credit with a variable rate, that interest rate is likely to get higher as the year continues.
Top Fed officials have been hinting toward interest rate hikes for months, which has also pushed up some interest rates on longer-term loans such as mortgages. While credit card and auto rates are tied closer to the immediate changes in the federal funds rate, home loans are more closely tied to where banks expect the Fed to end.
“The most direct way for households to encounter the interest rate increases in their mortgage rates,” said Derek Tang, co-founder and economist at research firm Monetary Policy Analytics.
“Treasury yields and mortgage rates have risen already in anticipation.”
Prospective home buyers are likely to see their interest rates on mortgages rise throughout the year. Bethune said it’s likely that many consumers who were planning to buy homes later in 2022 may do so soon to avoid a higher mortgage rate.
As households spend more of their budget on interest, Tang said they will likely spend less on consumer goods — which have grown 7.9 percent more expensive over the past 12 months, according to Labor Department data. Lower demand would ideally lead to slower price growth.
Less leverage for workers
Fed Chairman Jerome Powell told lawmakers last week it was crucial for the bank to raise interest rates and cool off an “overheated” labor market. There are nearly two open jobs for every unemployed American seeking work, forcing businesses to compete over candidates with ever-higher wages amid steady consumer spending.
“If a business wants to borrow to expand or to keep its operations going, you will have to pay a higher interest rate on those business loans,” Tang said.
“That will make businesses a little less likely to keep bidding up for labor,” he continued. “They might need to make a decision about how many people to hire and how much to pay them.”
While higher wages are generally good for workers, unfettered wage growth can push inflation higher as businesses raise prices to preserve their profits. Those higher prices then put more pressure on household budgets, prompting workers to ask for higher wages — a dynamic known as a “price-wage spiral.”
“They might be getting raises, but the raises aren’t keeping up with inflation, so it’s a lot better if inflation was actually a little lower,” Tang said.
Americans who have not gotten big raises yet may not see their wages rise as fast as those who switched jobs or negotiated better pay before the Fed began hiking.
Even so, some left-leaning economists are concerned that raising Fed rates will harm Americans who’ve yet to find their financial footing after several waves of COVID-19.
“Rate hikes will increase unemployment, slow down wage growth and hurt the very people who are bearing the brunt of recent price increases. Throwing cold water on the economic recovery will only calcify long-standing inequities in our labor market, harming all of us,” said Rakeen Mabud, chief economist at the Groundwork Collective, a progressive research nonprofit.
Less froth in financial markets
Higher borrowing costs for businesses also means narrower profit margins and higher standards for lenders. The ultra-low Fed funds rate through much of the past decade helped fuel a massive rally in the stock market, only briefly derailed by the COVID-19 pandemic. But expectations of higher rates have been among several factors behind the stock market correction that began this year.
“When the stock market is booming, even if people are not cashing out and selling their stock, they feel a little more comfortable spending,” Tang said. “However, in the opposite situation where you might think that your portfolio looks like it’s not gonna grow as much anymore, you might cut back on spending a little bit.”
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