Recent rate hikes by the Federal Reserve, including a hefty one this week of 0.75%, reflect a serious desire to lower the prices of everything from lettuce to laptops, but with inflation festering at 8 .6%, regulators still have a long way to go, according to Brian Henderson, chief investment officer at the Bank of Oklahoma.
In the weeks leading up to the Fed’s last meeting, many thought it would raise rates by 50 basis points – half a percent. But the outlook changed after consumer price index data released on June 10 showed inflation jumped 1% more than expected between April and May. The Fed’s more aggressive response indicates growing concern about inflation and could signal heightened potential for a deeper slowdown in the economy in the months ahead.
Although only certain aspects of a typical consumer’s finances, such as credit card interest, are directly affected by the Federal Reserve rate, people’s wallets and nest eggs are likely to be indirectly affected. For instance:
• Savings: The rate hike is good news for savers, as interest rates paid on bank deposits, including savings accounts, generally rise (or fall) with the federal funds rate, but not exactly the same way. Money market returns will also increase with the rate change. While interest rates on accounts and money market yields won’t rise by three-quarters of a percent, they could rise by half, Henderson said.
• Variable rate loans, including home equity lines of credit, adjustable rate mortgages and credit card debt. Consumers will pay higher interest on variable rate loans tied to the federal funds rate. Credit card interest rates, for example, rise and fall with the prime rate, which is based on the federal funds rate. Businesses with outstanding variable rate loans, such as those financing equipment on revolving lines of credit, will also feel rate hikes. One option for businesses is to refinance on longer-term, fixed-rate equipment financing options in anticipation of further rate hikes.
What could be indirectly affected?
• Jobs: inflation means more than high prices; it also means higher salaries. To reduce wage inflation, the Fed must reduce demand for workers, Henderson said. “Companies need to start raising the prices of services to compensate for the labor market wages they pay,” he said. “It can get out of control like what we had in the 1970s and 1980s.” The Fed’s series of rate hikes should help rein in wage inflation by encouraging companies to delay expansion plans, hiring and other spending. That means workers could see more hiring freezes and possible layoffs. However, by raising rates in increments rather than tightening the brakes on the economy, the Fed is trying to avoid massive layoffs, Henderson said.
• Investments – at least in the short term. “It’s a challenging environment right now for financial markets and the economy with Fed rate hikes, war in Ukraine, COVID-19 restrictions in China, and inflation in the United States,” he said. Henderson said. Markets don’t like uncertainty, so your investments may struggle in the short term, but it’s important to keep a longer-term view when looking at your retirement savings. “Investors saving for retirement should stick to their long-term plan. Pension contributions paid now are investing in the highest returns we’ve seen in nearly five years, and stock valuations based on current earnings estimates are very reasonable.
Holding that longer-term view should also help people keep current economic conditions in perspective, Henderson said.
“The economy will slow down, but it’s ultimately good for the United States and good for consumers as prices come down,” he said.