The promise or threat of an imminent increase in interest rates by the Federal Reserve has been looming for some time now. The Federal Funds rate, or benchmark rate, has been at or near zero percent since the height of the financial crisis in 2009.
Many economists and pundits expected Federal Reserve Chair Janet Yellen to announce a raise at the
Federal Open Market Committee meeting in September, but she cited too many risk factors that figured in the decision to hold firm. The most recent jobs report released on October 2nd, illustrating slowing job growth, emboldens that decision.
However long the delay, be it next week or next month, the rates will rise. So how will this move effect the average American?
Banking: Those with money parked in savings or money market accounts know the returns have been minuscule for several years, barely outpacing and sometimes being eclipsed by the rate of inflation.
According to
Bankrate.com, the current average return for a money market or savings account is 0.51% or just over one half of one percent. That means if you were to have $10,000 in a savings account, and made no other contributions or withdrawals, after one year you would earn $51 in interest. Sure, your money is safe but it is not working for you.
With a Fed raise of the benchmark rate, that savings rate will bump up a bit but not enough to notice. In fact, unless it is funding your Emergency Fund (enough to cover six months worth of expenses) you'd be better off taking that money out of savings and paying down high interest accounts, namely credit cards.
Annual percentage rates on credit card accounts, however, may or may not rise with a Fed Funds rate hike. Ultimately it is up to the card issuers to raise rates, and they don't want to alienate their best customers. Competition for consumers to carry their cards is fierce and issuers know lower rates attract customers. Issuers may opt to keep rates lower and phase out the "zero-percent interest transfer" promotions that are so ubiquitous in the current climate.
Consumer Loans: A hike in rates for banks will almost certainly be passed to consumers. New auto loans and home mortgages, while not necessarily tied to the Fed Funds rate, generally move in lockstep with it.
While rates are still at historical lows, a slight uptick won't break the bank and probably won't suppress car and home buying. However, if you've been considering refinancing in the future, now may be the time to execute that strategy and lock in a lower rate, before the rates do indeed go up.
Investments: As this is a daily story topic on the financial networks and news outlets, the market is well aware of this inevitability. Even though the exact level of increase is not known, the market has already accounted for an increase and securities have been priced accordingly.
Either a raise or lowering of interest rates is generally done in stages rather than all at once so its effect will be gradual. The best approach is to invest for the long term and not let the everyday ups and downs of the market effect your investment strategy.
As the economy hums along, new jobs are created, tax rolls swell and the Gross Domestic Product (GDP) continues to grow, the threat of inflation looms. The Fed will lower rates to make borrowing not quite as attractive, thus reducing the number of dollars out there in the market. It is designed to balance the economy, so it is not growing too quickly or too slowly. The Fed only raises rates in the midst of healthy, robust economy. And while it may bring some short term pain, its generally a sign that good times are here again.
