On March 16th, the Federal Reserve Open Market Committee announced the first interest rate hike since 2018. While the increase was just 0.25 percent, the Fed also outlined a plan to raise rates six more times over the course of 2022.
Though aggressive, this tighter monetary policy is believed to be key to fighting inflation that has reached multi-decade highs. At last count, inflation was running at 7.9 percent.
As interest rates increase, key aspects of the economy will be impacted by a higher cost of borrowing. One of the most crucial of these is the housing market, which for the last two years has been on a white-hot streak of price and demand increases.
Other facets of financial life, including stock prices, auto loan rates and even credit card rates, will also see the effects of the Fed’s plan to combat inflation. Here’s what you need to know about the Fed rate hike’s likely effects on these key areas.
How Do Interest Rates Affect the Housing Market?
Generally, rising interest rates exert downward pressure on the housing market. When buyers must pay higher rates on their loans, the number of homes sold tends to decrease.
It should be noted that interest rates do not have a direct impact on home prices. Over time, however, the effect of interest rates on demand can translate into higher or lower prices. When low rates increase demand for housing, prices tend to rise.
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How Will the Fed Rate Hike Affect the Housing Market?
It’s difficult to predict exactly how the Fed’s rate increases this year will affect housing because these increases will be taking effect in an extremely hot real estate market.
Historically low interest rates have certainly contributed to the current state of the market, but they aren’t the only factor. High demand among Millennial buyers and pandemic-related increases in home purchasing have also driven home prices to record highs.
Simply put, there is currently a fundamental mismatch between the supply of housing and the demand for it. A 2021 study found that U.S. housing supply lags demand by about 5.2 million single-family homes. This situation supports high housing prices, even before interest rates are factored in.
With that said, experts do expect rising interest rates to significantly cool the housing market over the course of 2022. By the middle of the year, purchases could fall by up to 30 percent.
Even if this doesn’t bring down the cost of homes, it should arrest the meteoric price increases that have defined the housing market over the past two years.
How Will the Fed Rate Hike Affect Mortgages?
While it could take several months for higher interest rates to cool off housing demand, the effect on mortgage interest payments is much more immediate.
Mortgage rates have already risen by more than 1 percent since November of 2021. As the Fed continues to increase its baseline interest rate to fight inflation, it’s reasonable to expect that mortgage rates will also continue to rise. By the end of the year, mortgage interest rates could average 5 percent or higher.
These rate increases can translate to enormous amounts of additional interest over the lifetime of a mortgage. For example, consider a 30-year fixed-rate mortgage with a principal of $350,000.
A buyer who took out this mortgage when rates were 3 percent would pay a total of about $181,220 in interest over the loan’s lifetime. At 5 percent, that number jumps to a staggering $326,395 in interest.
As such, small changes in interest rates can have serious impacts on both individual homeowners’ finances and the broader economy.
How Will the Fed Rate Hike Affect the Stock Market?
The housing market is far from the only part of the economy that will see substantial repercussions from the Fed’s plan to raise interest rates.
Typically, rising interest rates slow the growth of the stock market. Higher borrowing costs weigh on earnings and may drive down consumer spending. While the financial sector tends to profit from rate hikes, other sectors fare less well.
Interestingly, though, the stock market has bucked this trend so far in 2022. When the Federal Reserve announced its rate hike in mid-March, the market actually rallied instead of falling. This was likely due to growing investor fears surrounding inflation, which the coming rate hikes are intended to alleviate.
Runaway inflation could do more to damage consumer confidence and eat into investors’ returns than the comparatively modest rate hikes the Fed has planned. As a result, a rate hike struck investors as a positive development.
It should be noted, though, that this was only the first in a series of rate increases planned for 2022. Later hikes could temporarily drive share prices down. However, interest rate increases tend to have only a temporary effect on the stock market.
Under most circumstances, markets regain ground lost to rate increases within a year. Given the generally strong underpinnings of the American economy at the moment, it’s unlikely that higher interest rates will weigh too heavily on the stock market in the long run.
How Will the Fed Rate Hike Affect Crypto?
One of the most interesting questions surrounding the Fed’s 2022 rate hikes is how they will affect cryptocurrencies like Bitcoin.
In the immediate aftermath of the Fed’s announcement, the broader cryptocurrency market edged up by about 4 percent. Over the long run, however, higher interest rates could have a negative effect on digital currencies.
Although they are seen by some as inflation hedges, cryptocurrencies in today’s market are first and foremost investment instruments. As a result, they tend to respond in much the same way as stocks and other risk-oriented assets to macroeconomic news.
As interest rates rise, there’s a good chance that cryptocurrencies will begin to experience some headwinds. This is especially true if inflation does begin to ease, as investors who held crypto as an inflation hedge will be less likely to keep buying.
Some experts believe that higher rates could even cause a crypto crash, wiping out the gains of the past two years. Such crashes have happened before, and cryptocurrencies generally recover and continue to advance within a few years.
The consensus, however, is that these currencies are not insulated from the effects of higher rates and will likely have a rough year as the Fed pursues its plan to bring inflation under control.
How Will the Fed Rate Hike Affect Auto Loans?
Auto loans are among the brighter spots when it comes to the effects of rising interest rates.
A combination of high demand due to low rates and a global chip shortage affecting supply have pushed automobile prices to record highs.
Higher interest rates could rebalance this equation and somewhat reduce demand. Manufacturers are also slowly moving past parts shortages, meaning that there’s at least a chance that car prices could come down in 2022, even if interest rates on auto loans do go up.
How Will the Fed Rate Hike Affect Credit Cards?
Unlike auto loans, increases in interest rates will likely hurt consumers who make significant use of credit card debt. This is because most credit cards have variable APRs, allowing rates to adjust in accordance with the prevailing market.
Consumers with large balances on variable APR cards could find themselves facing higher interest payments. As the Fed continues to raise its rates, credit card rates could spike and impose high costs on consumers.
Higher rates could be especially troublesome at a time when credit card debt is already growing. In the second half of 2021, card balances in the US grew by $52 billion.
Higher rates and larger balances will likely eat into household budgets and extend the payoff times for Americans trying to reduce their debts.
The best course of action for these consumers is to pay off as much credit card debt as possible before rates move higher in the coming months.
How Will the Fed Rate Hike Affect Savings?
A final aspect of financial life to consider in the context of rising interest rates is savings. The relationship between savings and interest rates isn’t as straightforward as one might expect, though.
On the one hand, savings accounts will be able to pay higher interest rates as a result of the Federal Reserve raising rates. Although it will take some time for accounts to respond to the new rate environment, many savers can reasonably expect to see higher yields on their savings accounts by the end of the year.
On the other hand, higher interest on mortgages, auto loans and credit cards will likely reduce consumers’ savings rates. In order to make interest payments on these debts, households may have to dip into money that could otherwise be saved.
Debt-free savers will be rewarded with higher rates of return, but those who still have debt will likely see their ability to save reduced.
It’s also worth noting that the current inflation rates will vastly outpace the modest increases in savings yields for the foreseeable future. Even if savings accounts begin to yield 1 percent or more, the current rate of inflation would eat into the value of the saved money by a much larger amount. This largely nullifies the positive effects of higher interest rates on savings accounts.
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