5 Reasons How the Fed Interest Rate Affects Your Life

The US Federal Reserve raised the interest rate by another 0.25% last week, setting the target interest rate at the range of 4.75%-5%. The rate hikes have been going for a year. How does it affect your daily life and how are you going to take advantage of it and be “MoneySmarter”?

We’re gonna break things down for you—some tips about how you should spend and how you should invest to ride on these waves.

What’s the US Federal Mission?

All the interest rates change are all related to the sole director of the scene—the US Federal Reserve. Being the Central Bank of the strongest economy in the world, the Fed has the option to make a call on how strong or how weak the US dollar is by adjusting the interest rate.

The first mission of the US Federal Reserve is to keep the US Economy to grow steadily—keep both unemployment rate and inflation low.

However, that is quite the mission impossible. Why?

When the Fed started to lower the interest rate in 2008

When the economy is in a slump, marked by low spending and a halt to company expansion, the Fed can lower interest rates to bring down the borrowing cost and encourage business expansion to create more economic activities.

Take a step back to 2008—the collapse of the Lehman Brothers triggered a series of collapse of financial institutions due to overexposure in subprime mortgages. At the time, the Fed decided to bring down the interest to a near-zero level to encourage companies to boost expenses on expanding business, and ultimately create more job opportunities.

However, there were backfires with these actions. With more money being borrowed from the Fed, the US dollar money supply increased substantially. And that potentially increased the chance of inflation.

In short, the Fed is constantly juggling between the unemployment level and inflation to keep the US economy not too hot or cold.

Money is also driven by demand and supply

Back to nature, money itself can be seen as a commodity as well. If the low interest rate prevails and thus more lending activities happen in the market, you can imagine the money supply is more likely to increase. (More money being lent by financial institutions.) With a constant demand for money, the value of money can be expected to decrease (,which means everything can become more expensive).

And that triggers an inflation—the general price level increases. (Everything you buy has become more pricey and expected to be more expensive.)

Rate Hikes to Calm Down the Market

When the market is over-hyped and people are borrowing money to buy everything under the sun, instead of investing in their businesses, it can cause inflation to run rampant. In such cases, the Fed will step in and raise rates to nip inflation in the bud.

With the incoming inflation on slight, the Fed began the journey of rate hikes, starting to raise interest rates from 0.25% – 0.5% in Mar 2022, and to 4.75% – 5% in Mar 2023. When the Fed raises the federal funds target rate, it makes borrowing more expensive for businesses and consumers, and people spend more on interest payments.

This increase in borrowing costs may cause some people to delay projects that require financing. It also encourages people to save money to earn higher interest payments, which usually lowers inflation and slows down economic activity, basically cooling off the economy.

The Interest Rates Increase Impact on Daily Life

The US interest rate may seem distant from our daily lives, but in reality, there is much to consider when it comes to an interest rate increase. Think about your mortgages, your investing strategies, as well as your interest amount arising from your idle cash in banks.

Interest rate and mortgages

The most direct impact of an increased interest rate is the monthly mortgage repayment if you’re borrowing under the Prime-based rate. Let’s explain it with an example: What the 0.25% interest rate rise means for your mortgage and savings?

If you’re taking a mortgage of HK$2,500,000 with 30 years of term at the original rate of 2.375%, paying HK$9,716 monthly payment. An 0.25% interest rate increase means a monthly payment reaching HK$10,041, giving an extra cost of HK$325 per month.

If you’re looking for detailed mortgage information, check out MoneySmart’s Best Mortgage Loan Rate Comparison (with Cash Rebate Offer!)

Interest rate and investing

When the Fed raises interest rates, borrowing money becomes more expensive. This can have an impact on the specific sectors in the market, such as:

• High-growth stocks like Tesla, as companies will have to spend more money to run their business, which can lead to lower revenues and earnings. This could affect their growth rate and stock values.
• Financial stocks like HSBC, banks will earn a larger revenue from the increased 10-year treasury yields.
• Energy stocks are expected to react positively with rate hikes, holding the assumption of a healthy economic growth.

But beware, when there’s no holy grails when it comes to investing. Consider your risk and remember to consult your financial consultant before making any investment decision.

Interest rate and bonds

Bonds are directly affected by changes in interest rates. If the Federal Reserve increases rates, the prices of existing bonds will decrease. This is because the new bonds with higher interest rate payments will be available soon, making existing bonds less attractive to investors.

In short, when the Fed increases the rate, the bond price decreases.

Interest rates and saving account

When the Federal Open Market Committee (FOMC) raises interest rates, it can be a bummer for borrowers but a boon for savers. That’s because the rate also determines the APYs of deposit accounts. So, if the FOMC increases rates, banks will also increase the interest earned from deposit accounts.

Check out the Best Saving Accounts in Hong Kong to get the fixed deposit interest rate Hong Hong here.

Interest rates and credit cards

The higher the interest rate on your credit card, the more expensive it is to carry a balance. When the interest rate increases, the credit card rate follows as well. You might want to consider paying off your debt as much as possible or consider getting a personal loan with a lower interest rate to pay off your credit card balance.

The Market Beacon–The FOMC meeting

If you want to better plan your budgeting or build your investment strategy, you may keep your eye on the regular FOMC meeting; they set a target range for the federal funds rate on it.

Want to learn more about FOMC, check out FOMC: What Is It and What Does It Do? How Does It Affect The World Economy?