The Federal Reserve announced a 75 basis point rate hike on Wednesday, a 50 percent larger hike than the central bank originally announced for June.
The move comes after inflation hit a new 40-year high last week and consumer prices soared 8.6 percent from a year ago.
Fed watchers predict the bank’s benchmark Federal Funds The interest rate will continue to rise throughout the year, perhaps faster than initially expected, if higher rates don’t ease.
Even with the rate hike, rates will still be around 1.6 percent, close to all-time lows.
Here are five ways a rising interest rate environment will affect American wallets and the economy:
Mortgage, car and credit card payments will increase
The Federal Funds Rate sets the rate at which banks and credit unions can lend each other money when determining their capital needs to invest throughout the economy.
Banks that lend money at the Federal Funds rate must then charge the people and institutions that borrow money from them a comparable rate. So, an increase in the funds rate leads to higher rates in the credit markets, mortgage markets, and in any industry that relies on financing schemes to make payments.
This means higher monthly home and car payments and a higher price tag on outstanding credit card debt.
Mortgage rates are already rising sharply. Interest payments on the US benchmark 30-year fixed-rate mortgage made the biggest one-week jump in 35 years, hitting 5.78 percent Thursday, up more than half a percentage point from the week before.
That means a mortgage payment for a median $400,000 home after a 20 percent down payment would now be about $1,875. Last year, the monthly payment for the same house would have been $1,335. That’s more than a $500 difference per month.
The stock markets fall and experience dramatic price fluctuations
They’ve increased prices consumers pay mean that people tend to limit their spending, which lowers the demand for goods and services. The result for companies is lower earnings, making investors less willing to pay for ownership interests and lowering share prices.
Since January, most major US stock indices have fallen about 20 percent and entered what is known as a bear market, or an extended period of falling share prices.
The Dow Jones Industrial Average is down 18.6 percent this year, falling below 30,000 on Thursday from a January high of 36,800. The S&P 500 index has fallen from a high of 4,800 to below 3,700 over the same period, down more than 22 percent.
The tech-heavy Nasdaq, whose companies tend to hold extra debt making them particularly vulnerable to rate hikes, is down more than 30 percent.
Since March, when the Fed began raising rates with a modest target range of 25 to 50 basis points, the Dow is down 12 percent, the S&P is down 16 percent and the Nasdaq is down 20 percent.
It’s getting harder to find a job
Price increases that squeeze demand are also forcing companies to cut costs, and one of the first places they do this is in the workforce.
According to Desmond Lachman, economist at the American Enterprise Institute (AEI), a right-wing think tank in Washington, the housing market is a clear example of this process.
Mortgage rates, which “were just over 3 percent at the beginning of the year, are now around 6 percent. This means that people who could afford a $100 house earlier this year can now only afford a house for around $70. That means there’s a whole lot less demand for houses, so house prices start to level out and go down, and builders don’t want to build as many houses, and then people don’t get employed,” Lachman said in an interview with The hill .
While this may sound like a bad thing, it has long-term positive implications for the economy, which is posting some of the highest job numbers in decades, with around 96.4 percent of jobseekers currently employed and 11.4 million vacancies, according to the Labor Department.
A looser labor market means companies don’t have to constantly charge higher prices to generate profits for their investors, and this can lower inflation and stretch the value of a dollar.
Although higher rates will spell the end of the nominal wage gains that workers have benefited from during a period of labor shortages, the increased purchasing power of the dollar should really boost paychecks.
The likelihood of a recession is growing
As the Fed seeks a “soft landing” for the economy — bringing inflation down to 2 percent without triggering a recession — many market commentators see a recession increasingly likely over the next year or two.
“I’m not so concerned about a return to the inflation levels of the 1970s, but about a deep recession that will soon take inflation way down,” said AEI’s Lachman.
Fears of a serious recession, or the combination of slowing growth and weakly valued money known as “stagflation,” are now being compounded by geopolitical issues that are beyond the reach of the Fed’s policy levers.
These include the war in Ukraine, which has impacted global food prices, and lockdowns in China, which have affected production pipelines. Major supply chain problems, hampered by sky-high energy prices and port congestion, are also powerful forces weighing on the global economy.
A recession for Americans after interest rate hikes would be a double-edged sword. While this will lower prices in the medium term, it will also mean a period of reduced economic activity. This will translate into lower returns on investments in the stock and other securities markets, poorer performance from retirement plans like 401Ks, and lower nominal wages.
The government deficit is getting expensive (Taxpayer) more
With interest rates near or near zero, economists usually don’t worry about the government deficit, which is currently worth about a year and a half of output or gross domestic product (GDP).
The US economy’s resounding cyclical recovery after the near-total shutdown of the private sector due to the pandemic has taken a toll on US government debt. The Congressional Budget Office’s most recent projection for the deficit was $1.7 trillion lower than expected.
But as interest rates rise, pleasant surprises like this become increasingly rare as paying down the national debt will require more taxpayer money.
“The government will have to make more interest payments,” Lachman said. “Furthermore, the progress we’ve made in reducing the deficit will also disappear, because if the economy stalls and goes into recession, that means the government will raise less taxes.”
Lachman added, “The wrong thing for the Fed to do — especially after the Biden package of $1.9 trillion, 8 percent of GDP, the kind of fiscal stimulus we’ve never had before in peacetime — was for the Fed to sit simply zeroed in on interest rates and then kept telling himself inflation was transient and had nothing to do with the money supply increasing 40 percent in two years. That was madness.”