The Battle Against High Inflation Begins
Last Wednesday, The Federal Reserve took the next step in combatting the high rate of inflation. They increased the fed funds rate by 0.25%. On the surface, this does not seem like a major step when the current rate of inflation is near 8%. But it is important to remember these rate changes often take six to twelve months to have an impact.
The Fed's decision did not surprise anyone. Comments about raising interest rates began late last year. The surprise came from the comments made by Chairman Jerome Powell. Original forecasts from the Fed pointed to four rate increases this year. His comments indicated there could be six more moves in 2022. This could push the Fed Funds rate from zero to 1.75%.
What does this mean to you?
For borrowers, your loans will have higher interest rates. In early 2021, the interest rate on a 30-year mortgage fell to 2.65% a historic low. It would not surprise us to see mortgage rates twice that high later this year. This will also increase interest rates for other types of debt. Home equity loans, car loans, and credit cards will all have higher interest rates.
If you are a borrower, you may want to review your existing debts. If any of the loans have a variable rate you should consider finding ways to eliminate those.
Increasing interest rates create challenges for your existing bond positions. As interest rates increase, bond prices move in the opposite direction. In the bond market, yields have already increased. Yields on 10-year treasuries are now well over 2%. At the end of 2021, the yield was 1.5% This has caused existing bond investments to decrease in value.
If you are a saver, these higher interest rates are a welcome change. Rates you can earn on CDs or savings accounts will begin increasing in the coming months.
The Fed's Mandate: Control Inflation
The federal reserve has two mandates: maintain a low unemployment rate and control inflation. Interest rate policy is one tool they use to manage inflationary pressures.
Another tool is buying bonds from banks. During the pandemic, the Federal Reserve purchased bonds as a way to inject cash into the economy. They have announced they intend to reduce those bond positions beginning in May. This action can also increase interest rates on longer-term bonds.
The Big Question: How will this affect the economy?
The federal reserve has a difficult task. If they don't do enough, inflation continues to hurt us all. If they are too aggressive, their actions can cause a recession. Getting it "just right" is almost impossible.
What Should We Expect?
We expect interest rates to rise over the next couple of years. As a result, you can expect continued challenges for both stocks and bonds. The first part of 2022 has already been frustrating and we know you are concerned.
Rising interest rates are not a new phenomenon. We've been through times like this before. We will use those experiences to help us guide you through these challenging times.