What Happens When the Fed Raises Interest Rates?

While interest rates remained low throughout 2020 and 2021, the Federal Reserve (Fed) is expected to raise rates as early as March 2022 due to high inflation. While the Fed only has control over the federal funds rate, which is the rate that determines how much financial institutions charge one another when they borrow money overnight, when the Fed raises rates, there’s a ripple effect that extends into certain areas of the average person’s financial life.

Many rates in the United States are tied to the federal funds rate. So, when the Fed increases interest rates, it affects the amount of interest consumers may pay for access to credit, including loans and credit cards. The Fed’s choice to raise interest rates also affects the interest savings account and certificate of deposit (CD) holders earn on their money.1

How Much Will the Fed Raise Interest Rates?

Until the Fed announces that they have raised interest rates, many financial experts tend to weigh in on the subject with their predictions. For example, Goldman Sachs Group’s economists forecast that the Fed will raise interest rates aggressively, as do their Wall Street peers. Some economists predict that the Fed will raise rates five times this year, taking the benchmark up to 1.25% – 1.5% by the end of 2022.

Goldman Sachs predicts that the Fed will raise rates incrementally in March, May, July, September and December of this year.

Their willingness to consider consistent interest rate hikes is due in part to the steady rise in inflation, which economists say is the fastest they’ve seen in 40 years. According to a recent government report, the Employee Cost Index rose 4% throughout 2021, which is the fastest it’s risen in 20 years.2

What Impact Will Higher Interest Rates Have on the Economy?

When the Fed decides to raise the federal funds target rate, they want to increase the cost of credit across all parts of the U.S. economy. As a result, loans are more expensive for consumers and businesses.

Some may decide to put off projects that require financing, such as buying a home or property, refinancing property, or embarking on a buildling project. At the same time, savings earn more interest, so many people see the Fed increasing rates as an indicator that they should shift from a spending to a saving mindset.

When the Fed increases rates, it tends to lower the supply of money in circulation, which may help lower inflation.

Stocks

As market interest rates rise, stock values may decline. When the Fed raises interest rates, borrowing money becomes more expensive and the overall cost of doing business goes up. Over time, these trends may contribute to lower earnings for publicly traded companies.

Fed rate hikes also affect market psychology, resulting in more negative feelings about overall market conditions. Traders may respond to increased rates by selling off stocks quickly to get ahead of any potential losses.

Bonds

When the Fed decides to increase rates, market prices of existing bonds automatically decline in response.

Savings Accounts and Bank Deposits

Interest rate increases from the Fed produce higher interest rates for savers. The Fed funds rate serves as a benchmark for annual percentage yields (APYs) on savings accounts and other bank deposits, including certificates of deposit (CDs).

Consumer Credit

The effects of increased interest rates show up more slowly with consumer credit. Personal loans, credit cards, and lines of credit interest rates may increase over time when the Fed steadily increases rates, as economists predict they will throughout 2022.

Variable-rate loan interest rates change quickly when the Fed increases interest. Interest rates on variable rate loans are tied to the Fed funds rate. Fixed-rate loans are not affected by changes to interest rates from the Fed.

What is the Impact of a Fed Rate Hike on Mortgage Rates?

The Federal Reserve doesn’t make decisions about mortgage rates. Their decision to increase the Fed rate could affect mortgage interest rates in the future, however. With the Fed indicating

that it may raise rates in 2022 for the first time since 2018, long-term mortgage rates could start to go up. Economists expect interest rates on mortgages to rise during the next year.

Can You Still Refinance Your House?

The Fed won’t make a decision about whether to increase interest rates until March 2022, and even then, changes will be incremental. You can refinance mortgage loans at any time, regardless of what the Fed decides to do about interest rates.

Your decision about mortgage refinancing is only partially based on interest rates. If the current interest rate you qualify for is less than the interest rate on your current mortgage, refinancing your home loan may make a positive impact on your finances by lowering your monthly payments or shortening the amount of time you’ll make mortgage payments, depending on your financial goals.

1 Brain O’Connell, 2022, What Happens When The Fed Raises Interest Rates?, [Forbes.com], Accessed 29 Jan. 2022.
2 Simon Kennedy, 2022, Goldman Sachs Predicts Fed Will Raise Rates Five Times This Year, [Bloomberg.com], Accessed 29 Jan. 2022.