Everywhere in the financial news we have heard that the Fed has raised their rates and will continue to do so. The questions become how much will they raise them? How often? How many times in 2022? How does this impact us? So, let’s talk about it.
The Fed is projected to issue a rate hike in every meeting they have throughout the remainder of the year and in total this will equal roughly 6-7 rate hikes.
When I say “rate hike”, what I mean is that the Fed sets the Federal Fund Rate. What that is, is the interest rate that banks charge each other when they borrow money from one another. So when I say they are raising rates, what that means is they are increasing the rate that banks charge each other for borrowing. I’ll explain more as we go.
However, this is a projection. The Fed has made it very clear that they will act accordingly depending on how the economy is reacting to the rate hikes or what is currently happening. At the end of the year, it may be more or it may be less and there isn’t a way for us to know until December 31, 2022 when we can look back and see.
However, we still do have the ability to put together why they are raising rates and how it will impact us.
Let’s start with why.
If we rewind the clock back to March/April of 2020, I think we can all remember that Covid started to greatly impact our lives here in the United States. The world comes to a halt, people don’t know what to do, we all remember. So, in turn as the Fed was seeing this happen, they lowered the Fed Funds Rate to effectively zero, 0.05% to be exact.
Again, the Fed Funds Rate is the rate that banks charge each other to loan money to one another. This rate also determines the rate that banks will charge their customers. If the rate is low between banks, the rate we pay on our debts/loans will also be low because the bank doesn’t need to make up any cost they are paying because it is so low for them to borrow too. But, if it is higher, we will pay more on our debts/loans because the bank is paying more on their end as well.
So, the Fed Funds Rate was pushed down to zero to spark consumers like us to borrow and spend more money because it was so easy and cheap to. The banks didn’t have to pay any interest on the money they were lending each other, and in turn we had very low interest rates on our debts/loans.
This helps spark the economy and give it some life as we are all going to spend more and take on more debt because it is so easy and cheap to pay off over time. The Fed did so 2 years ago because they were afraid of what Covid would do to the economy and it has been like this since then.
Fast forward to today. We are in an inflationary period for a number of reasons, but one of them is because it is so cheap to borrow and spend money that it is allowing us to spend more and more on products and services, in turn pushing inflation higher.
This leads us to why the Fed is raising rates now. The Fed knows that if they can slowly increase the Fed Funds Rate, it will in turn drive up the interest rates that we as consumers pay on our loans/debts and we will spend less overall. This will push down the inflation we are seeing because we aren’t spending as much money and the economy will normalize.
The increase in interest rates will also slow the ability of businesses to borrow money for operations or investment, also dampening inflation
That’s really how the Fed raising rates impacts all of us.
Higher rates = people borrowing less (mortgages, cars, credit cards, etc), people spending less, businesses borrow less, demand cools = Inflation decreases
What the Fed has to do is be sure that they are increasing their rates at a pace that is neither too fast or too slow.
Too fast and they will push demand down too quickly which is not what they want for the economy.
Too slow and inflation will continue to run up while we want it to come down.
Ultimately, it’s a balancing act the Fed has to perform in increasing the rates but it is necessary for them to do so.