The Federal Reserve recently raised the federal fund rate by 25 basis points, on September 26, 2018 at the September FOMC meeting. The Fed projects another rate hike by the end of 2018, and another three in 2019.
In this article we’re going to look at how consumers and the stock market are affected by the recent fed rate hike, and how interest rates affect them in general.
How Does This Affect Consumers?
The Fed raises rates when they want to decrease the supply of money in the economy. By increasing the federal funds rate, they make it more expensive for banks to lend money to each other, and borrow from the Fed. Because of this, banks raise their interest rates across the board, whether it’s credit card rates, student loans, mortgage rates, or a commercial loan.
Seeing as the Fed intends to continue their rate hikes, those with adjustable-rate mortgages might consider refinancing into a fixed rate, if possible.
Consumers will likely see slight increases in their variable rate mortgages, credit card interest rates, and most types of borrowing they do. While 25 basis points is a minor rise, the Fed projects future rate hikes, so it’s something to pay attention to as a borrower of money.
On the other end, savers are finally rewarded in an economy that’s been punishing saving as of late. Savers can expect to see more favorable yields from savings accounts, CDs, and bonds.
How Does This Affect the Stock Market?
It’s rare for financial media like CNBC to go an hour without at least mentioning the Federal Reserve and their plans for interest rates. You may wonder why they pontificate about the Fed so often. It comes down to cost of capital.
Right now, the United States economy is in a growth period, where many companies are given rich valuations based on the futures. So, even if they’re unprofitable today, if they exhibit growth, investors want to be involved. Many of these companies borrow massive amounts of money to fund their growth. They do this through offering stock and bonds.
When a company finances their growth by raising debt, they offer an interest rate based on the inherent risk within the company, their industry, and the economy. During periods of low interest rates, like today’s economy, these companies can borrow money very cheaply. In turn, it makes sense for these companies to borrow a lot money, because as long as they can service the interest, which is low, they can keep borrowing and growing.
When the Federal Reserve comes out and states their intention to continually raise interest rates, that not only makes borrowing money 25 basis points more expensive across the board today, but it ensures that borrowing will be even more expensive in the future.
Looking at the other side of the spectrum, rising interest rates is usually bullish for financial stocks like banks and insurance companies. These companies hold a lot of cash which they can now lend out at a higher rate.
Summary
- The Federal Reserve raised rates by 25 basis points in
- Fed Chairman Jerome Powell’s comments have been increasingly hawkish as of
- The Federal Reserve intends to continue to raise rates through
- Consumers should try to become net-savers, rather than net-borrowers, in rising interest rate
- Rising interest rates is bearish for growth stocks, and bullish for cash-rich
Article By: Patrick Crawley
