What has been happening recently?
Everyone is saying… “Inflation”, “Rising Interest Rates”, “Higher cost of living”. So what exactly cost that? And why is our interest rate increasing?
Who is that? You may ask.
Fed – Federal Reserve, in short, Fed.
The mission of the Federal Reserve System is to foster the stability, integrity, and efficiency of the nation’s monetary, financial, and payment systems so as to promote optimal macroeconomic performance. Basically, they have to find the right balance – just right, not too hot nor too cold of the U.S economy.
When the economy booms and “runs hot,” distortions like inflation and asset bubbles can get out of hand, threatening economic stability. That’s when the Fed steps in and raises interest rates, which helps cool down the economy and keep growth on track.
So how are rising interest rates affecting you?
In any aspect of finance, you are subjected to the Fed’s fund rate one way or another.
So how? You may ask.
If you are wondering how exactly, here are four examples – from your savings and debt, to your buying power and job security.
1. Rising Interest Rate Effect on Inflation
First and foremost, the main reason why we increase interest rates is to curb inflation.
So, why does inflation occur?
Inflation occurs when prices rise due to increases in production costs, such as raw materials and wages. A surge in demand for products and services can cause inflation as consumers are willing to pay more for the product.
However, when inflation increases too rapidly, some action has to be put in place. This is when the Fed steps in, to increase interest rates to curb inflation. This will lead to consumer spending and demand decline, money-flows reverse and inflation is somewhat tempered.
Conversely, when interest rates decline, consumers spend more as the cost of goods and services are cheaper because financing is cheaper. Increased consumer spending means an increase in demand and increases in demand increase prices.
2. It could trigger a recession and a rise in unemployment
If the Fed raises rates too high in a short span of time, it could cool or even reduce the demand in the market. This will lead to the economy tipping which could potentially trigger a recession.
When many companies are anticipating a recession or when the world is in the midst of a recession, many companies tend to cut back on spending. Why so?
With higher interest rates, many companies may discourage hiring associated with business expansion. Such instances could be seen recently with many big tech companies laying off employees with the likes of Meta, Shopee, Netflix and many many crypto companies.
Companies turn to reduction of expenses and cut jobs to retain the lack of revenue growth and profit. Thus, with rising interest rates, it will trickle down the economy affecting many people lifes.
3. Bigger Earnings for Savers
6 – 12 months of emergency savings? Everyone preached that when you are starting out to invest.
If you don’t have a savings account, now’s the time to open one to build your emergency fund!
Or if you are looking at the latest credit card deals available, here are some of the best deals you can get! Interest rates on Savings Accounts, Fixed Deposit Accounts, T-bills and Singapore Savings Bonds are rising because of the Fed’s rate hikes.
Thus, in times like this, you should definitely be strategic about where you keep those savings. High-yield savings accounts which offer solid returns on savings with high liquidity is probably what you should be looking for!
Some important factors you have to consider are fees, minimum deposit, balance requirements and withdrawal options when choosing such instruments to place your savings.
4. Borrowing Money is More Expensive Now
When the Fed increases interest rates, it becomes more expensive to borrow money.
The average of the rates banks negotiate for overnight loans is called the effective federal funds rate. This impacts the market rates like the prime rate and SOFR. It translates to higher rates for credit cards, auto loans, and any industry that relies on financing.
Households are less willing to spend as a result, and businesses don’t have as much access to capital to grow or expand their businesses. What’s worse, businesses typically pass on those extra costs, making it a “double-edged sword” for consumers.
With interest rates rising, you’ll want to try to borrow less and work on paying off any debt as fast as you can. Firstly you should get rid of high-interest debt such as credit card debt as they could amount to over 20%.
Hence, in times like such, be it companies or consumers, many will tend to cut back on spending. Borrowing money is constantly more expensive which is why rising interest rates affect all of us.
5. Increased Volatility in the market
Investors tend to panic when the Fed takes drastic action, and that translates to more volatility in the markets. There will likely be more downward pressure on the stock market in the coming weeks and months, but the Fed’s decision to raise interest rates should not steer your long-term investments off course.
With the first rate hike, in March of 2022, the market has shown a steady decline.
Historically, data have proven that the stock market always rises over time. The best-performing portfolios are the ones that have the most time in the market. With that in mind, the best response is to stay on course and keep investing.
One quick and easy way is to prioritize low-cost, broad-market index funds such as the S&P 500 and the Nasdaq 100. They are the most effective way to build wealth over time and always maintain a long-term mindset.
While there could be volatility in the market, one should always look at the big picture. Understand why and what you are investing in, this way you will not be feared by the volatility!
Many news outlets and blogs may have talked about this, “don’t fight the Fed”.
As some may be crying and complaining over spilled milk. Instead of agonizing over the fate of the economy, put your financial future into your own hands.
Start by going back to the basics and making small but impactful money moves. This could be things like adjusting your budget, building and emergency fund and paying down debt.
Not all Fed rate hikes are going to impact you directly and not all corners of your financial world are going to be affected by rate hikes. Remember what your strategy is and revise it periodically. Rationalise what is your strategy and don’t act in a rush.
The most important takeaway you should understand is,”Diversification is key and understand your risk tolerance!”
Disclaimer: The information provided by LearnToInvest serves as an educational piece and is not intended to be personalized investment advice. Readers should always do their own due diligence and consider their financial goals before investing in any stock.