How the Fed’s New Interest Rate Hike Affects Inflation and You
On Wednesday, the Federal Reserve took its fight against inflation to a new level by announcing that it was raising interest rates by 0.75%, the largest increase the central bank has adopted since 1994.
The federal funds rate target, or the rate at which banks lend money to each other, is now 1.5% to 1.75%. While an increase of this size is in line with expectations, it is up from the 0.75% to 1% range set by the Fed last May. It also represents a significant change from the Fed’s approach at the height of the pandemic, which was to keep rates near zero in hopes of stimulating economic activity.
While it may sound like a bunch of jargon, Fed rate hikes can actually have a significant impact on the wallets of everyday Americans, especially amid concerns about rising prices and the possibility of a recession. .
Here’s what you need to know.
Why did the Fed raise interest rates?
The Fed likes to see low and stable inflation because it allows individuals and businesses “to make smart decisions about saving, borrowing, and investing, which helps the economy run smoothly,” according to his website. Ideally, this means he wants inflation to average around 2% over the long term.
Inflation hit 8.6% in May, hitting a 40-year high for the fourth time this year. The Fed is now trying to get the situation under control. The main way to do this is to raise the federal funds rate.
How big is the Fed’s new rate hike?
The 0.75% increase is so large that Fed Chairman Jerome Powell said last month that a hike of that magnitude was “not something the committee is actively considering.” It’s the the biggest since November 1994.
“We thought strong action was warranted,” Powell added at a news conference on Wednesday.
The Fed has raised rates twice this year so far, raising them 0.25% in March and 0.5% in May. Experts originally predicted seven rate hikes in 2022, but the details are constantly changing as prices keep climbing. (Ongoing problems with the supply chain and the Russian-Ukrainian war also complicated the situation and exacerbated inflation.)
As the Washington Post reports, the Fed is also grappling with criticism over its reputation. Powell, as well as US Treasury Secretary Janet Yellen, spent months insisting that inflation was transitory, but recently had to backtrack on those remarks. It is possible that the Fed will and will continue to take more aggressive action as a result.
“The Fed cannot afford to be seen as ‘lagging the curve’ when its inflation-fighting credibility is in question,” wrote Andrzej Skiba, head of U.S. fixed income team BlueBay. at RBC Global Asset Management, in an email to reporters.
What does the Fed rate hike mean to me?
When the Fed raises interest rates, it effectively makes borrowing more expensive. Christopher Jones, chief investment officer at Edelman Financial Engines, told Money in February that variable credit card rates and variable rate mortgages, for example, “tend to be very sensitive” and “rise based on what the Fed is doing.”
We’ve already seen mortgage rates rise from 3.5% in January, when the Fed started saying it would raise rates this year, to over 6% now.
This also means that it’s very important to make sure you don’t carry a month-to-month balance on your credit card, and if you do, you might want to put it on the card with the lowest annual percentage rate, or APR.
Investors should also be prepared for increased market volatility in reaction to Fed news. But when it comes to investment strategy, the best course of action is likely to stay the course. Charles Schwab’s Rob Williams recently told Money that “we don’t think people should make major changes” – as long as they have a diversified portfolio and focus on the long term.
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