The journey towards increased interest rates has been protracted ever since inflation reached its highest point of 9.1% in June 2022.
In the months that followed, the Federal Reserve implemented a sequence of eleven interest rate increases in an effort to rein in the escalating trend of consumer prices. The inflation rate in November 2023 was recorded at 3.1%.
The Fed’s decision on Wednesday, December 13, to halt rate hikes for the third consecutive month with a target of 2% indicates the central bank is optimistic about its progress in combating inflation, but maintains a cautious stance.
Thus, interest rates continue to be elevated, and further reductions by the Federal Reserve are still months away.
Functioning of monetary policy
The Federal Reserve exercises control over a single interest rate, namely the federal funds rate, which institutions utilize to borrow funds on a short-term basis. The most recent action maintains the federal funds rate target range at 5.25–5.50%. The decisions of the Federal Reserve regarding interest rates permeate the financial sector, influencing nearly all aspects of financing expenses and savings rates. The Federal Reserve employs interest rate management as monetary medication to:
Implement a policy of increasing interest rates with the intention of curbing escalating expenses, commonly referred to as high inflation, as gauged by the consumer price index.
Facilitate a resurgence during the polar opposite of an economic cycle by infusing liquidity into the financial system through the reduction of interest rates.
Maintain stable interest rates while the Federal Reserve deliberates on future courses of action, thereby permitting previous actions to solidify.
The Federal Reserve’s outlook for interest rates
The Fed stated in a statement issued subsequent to the declaration of an additional hiatus in interest rate hikes that “inflation has decelerated in the previous year but continues to be elevated.” The Fed plans to “continue to assess additional information and its implications for monetary policy” due to the fact that a robust economy can contribute to increased consumer prices.
The federal funds rate-setting Federal Open Market Committee members each maintain a 4.6% target for the end of 2024; this would necessitate three rate decreases the following year. However, such projections are “not a committee decision or plan,” according to Fed Chair Jerome Powell, and additional interest rate increases are possible “if appropriate.”
Describe how the actions of the Federal Reserve might affect your loans and accounts.
The impact of a paused rate increase on checking and savings accounts
Your short-term liquidity is contingent on your bank balance. This has left Americans treading water for years, earning virtually no income. The rates on deposit accounts have increased in tandem with interest rates. The Federal Reserve’s ongoing cessation of interest rate hikes will probably maintain deposit account rates close to their present level.
However, prudent savers should seek out the highest possible returns while providers contemplate reducing interest rate payments.
A check-in position
Checking accounts that accrue interest provide the lowest possible returns. However, you require the funds immediately, and if you effectively manage your financial flow, the bank will not hold the majority of that capital for very long.
Monthly interest on interest-bearing checking accounts averaged 0.04% across the nation in November 2022. After one year, that rate had increased to 0.07%. A smidge to a smidgen, on a scale of “not much interest” expressed in basis points.
Let us ascend the scale of interest paid in cash.
Savings institutions
It is advisable to place short to medium-term funds in a savings account. It is an element of your finance strategy of “easy in, easy out.” The monthly average interest rate on a traditional savings account at a physical bank in November of the previous year was 0.24%. November 2023 saw a value of 0.46%.
High-yield savings accounts offer greater returns— Yahoo Finance has identified high-yield savings account APYs of at least 4.5 percent. Your interest rate is compounded to produce the APY. Periods for compounding may differ between banks.)
Market money accounts
In order to achieve the return increase from a standard checking account to a money market account, you will likely be required to make a deposit ranging from $10,000 to $100,000.
The average national monthly interest rate in November of that year was 0.29%. The following year, it was 0.63%. That represents a marginal decline compared to the rate observed in October. Keep in mind, however, that is only an average. One potential investment for the second layer of currency is a money market account that offers above-average returns. You desire the funds to be readily available, rather than in a closed checking account.
Seek out a high-yield money market account to accomplish this. As long as the Federal Reserve maintains current interest rates, money market accounts with high yields will continue to be elevated. Once again, Yahoo Finance reports that high-yield interest rates are approaching or exceeding 4%.
What to do at this time is compare rates at physical and online banks. Maintain your short-term cash in a flexible state, maximizing its interest yield.
The impact of Fed policy on CDs
CDs have been blessed with good tidings this year. With the increase in interest rates implemented by the Federal Reserve, certificates of deposit gained value.
In November 2022, a 12-month CD was yielding a monthly interest rate of 0.90%. After a series of rate increases, the same-term CD was now yielding 1.85%. The highest-yielding CDs exceed 5.5% APY. Your interest rate is determined by the term and minimum deposit.
Assume a CD ladder in order to capitalize on the interest rate upswing.
At this time, generate interest on your mid-term funds through CDs. By employing the aforementioned ladder strategy, which involves staggered maturities, one can gain the advantage of increased interest rates while maintaining access to their funds without committing them for an extended period of time.
The implications of the most recent Federal Reserve action for mortgages and loans
Switching to the opposing entry in the asset/liability ledger. As a result of increased interest rates caused by the Federal Reserve’s contraction of the money supply, borrowers must pay more to lenders.
Individual credit
Personal loan interest rates increased from 8.73% at the onset of Fed rate hikes in 2022 to 12.17% as of August 2023.
Student credit
The resumption of payment obligations following the expiration of forbearance has brought student loans back to the forefront of the minds of those who still owe. The majority of federal loans have fixed interest rates, rendering them unaffected by Fed policy. Rates on private student loans may be variable, and increases in Federal Reserve rates may play a role.
For information regarding the interest rate associated with a current loan, please contact the lender or loan servicer.
The most recent initiative of the Biden administration, SAVE IDR, may grant eligible individuals reduced payments. In relation to income-driven repayment arrangements, notification of loan forgiveness has been extended to more than 800,000 borrowers.
In the interim, new student loan interest rates are increasing.
Mortgage financing on homes
Those who have considered purchasing a property within the last two years are familiar with this tale. The interest rates on home loans have skyrocketed. Freddie Mac reports that when the Fed rate increases began, lenders priced 30-year fixed-rate mortgages at approximately 4%. Since the end of October, home loan interest rates have decreased marginally but continue to meander around 7%.
Current mortgage rates are not directly influenced by the Federal Reserve; rather, they are determined by lenders monitoring financial markets. Nevertheless, in the event that elevated inflation persists in diminishing, it is probable that mortgage interest rates will subsequently rise. The descent will not be a diamond run. The decline in mortgage loan rates from 7% in 2001 to an annual percentage rate below 3% in 2020 spanned an entire period of almost two decades. And purchasers may not encounter mortgage interest rates that are priced at that level in the near future. Significantly higher than 7% is the 50-year mean for a 30-year fixed-rate mortgage.
Consider acquiring additional debt with extreme caution at this time, as interest rates continue to be elevated. When initiating a new loan, allocate funds for your monthly payment so that interest rates remain relatively stable. A favorable budget surprise would be the acquisition of a refinancing opportunity should interest rates indeed decline.
Implications of Fed interest rate rises for credit cards
Although the Federal Reserve’s efforts to curb inflation are currently mitigating the increase in consumer prices, previous hikes in interest rates have had an adverse effect on your credit card debt.
The average credit card interest rate increased significantly from 16.65% to over 22% during the most recent rate-hiking cycle initiated by the Federal Reserve. Undoubtedly, credit card variable APR interest rate fees will remain elevated so long as monetary policy remains unchanged.
Unless you pay off your credit cards during each billing cycle, minimum payments due will not decrease and interest charges on balances will remain high.
What should be done now: Prioritize paying off the credit cards you can, particularly those with the highest interest rates, and as your credit score permits, consider balance transfers to credit cards with lower interest rates or no interest. Consider a personal loan as an alternative option for credit card debt consolidation if you have excellent credit.
