What Happens When the Fed Raises Rates?

The Federal Reserve’s job is to keep the supply of money in the country’s economy. While the Fed has multiple tools to do so, its ability to influence interest rates is its most prominent and effective monetary policy tool. When we talk about the Fed raising interest rates, we’re referring to the federal funds rate, also called the federal funds target rate.

What Happens When the Fed Raises Rates?

When the Fed raises the federal funds target rate, it is done so with the goal to increase the cost of credit throughout the economy. Higher interest rates make loans more expensive for both businesses and consumers, and everyone ends up spending more on interest payments.

Impact on Stocks

Higher interest rates can have a negative impact on the stock market. When Fed rate hikes make borrowing money more expensive, the cost of doing business increases for companies. Over time, higher costs and less business could mean lower revenues and earnings for firms, potentially impacting their growth rate and their stock values.

Impact on Bonds

Bonds in particular are sensitive to interest rate changes. When the Fed increases rates, the market prices of existing bonds immediately decline. That’s because new bonds will soon be coming onto the market offering investors higher interest rate payments. To reflect the higher overall rates, existing bonds will decline in price to make their comparatively lower interest rate payments more appealing to investors.

Impact on Savings Accounts / Bank Deposits

While higher interest rates might be bad for borrowers, they’re great for anyone with a savings account. The fed funds rate is also a benchmark for deposit account annual percentage yields. When rates increase, banks react by increasing the amount you earn from deposit accounts.

Impact on Savings Consumer Credit

Consumer credit, like personal loans, lines of credit and credit card, respond more gradually to Fed rate increases.

TL;DR

Diversify your investments. If you have open lines of credit, try to clear them off systematically. You can use the Gauss app to clear your credit card debt and stay on top of your credit payments.