Why Are Interest Rates Going Up? What Investors Need to Know
It would be nice, almost uncharacteristically peaceful, if some new notion was not attacking your wallet every day. You work full-time at a job, sometimes multiple jobs, just to keep the lights on and food in the fridge — so why can’t the economy get its house in order?
The cost of goods, foods and services have all been steadily increasing, which makes it no surprise that interest rates are going up as well. But why are interest rates going up, and why does everything seem so expensive?
Rising Interest Rates Key Takeaways
When delving into the reasons as to the what, who, when, where and why causes of an issue, sometimes breaking it down piece by piece helps to understand the whole scenario.
What: What are interest rates? Essentially, they are the fee associated with borrowing money. The government sets benchmark rates and banks charge interest accordingly when loans are being lent or borrowed.
Who: Who is responsible for raising interest rates? The Federal Reserve is responsible for raising interest rates. The intention behind this is to slow down inflation by slowing down the economy. It may seem counterintuitive, but if people stop buying as many things — or cannot afford to — this decreases demand overall.
When: The COVID-19 pandemic is not only devastating emotionally, but also economically. The interest on short-term borrowing rates just went up again recently by 0.75 percentage points, which is on the trajectory to hit the target range of 3.75% to 4.00% in 2022. This is the highest it has been since January 2008. These increases could continue until inflation is considered under control.
Where: Where will you feel rising interest rates the most? As interest rates typically show up where lending and borrowing money occurs, you will feel these rising rates as an equity investor, fixed-income investor or as someone who puts a lot away into a savings account.
Why: Rising interest rates are in direct correlation with rising inflation. When interest rates are higher, it can be more discouraging to buy a house or car or take out a credit card. Raising interest rates is meant to combat inflation by slowing down the buying of goods, business growth and basically the entire economy.
What Are Interest Rates?
It would be ideal if everyone just had enough money to buy whatever they wanted, but in reality, big expenditures come with big loans. When you borrow money, unless it is from a friend or family member, chances are it will be from a financial institution, such as a bank. The additional expense on the loan is the interest rate. It is the fee that makes it worth it to the bank to loan you that amount.
High-interest rates mean more money out of the borrower’s pocket, especially when you are paying off something for years. When interest rates go up, sales go down, which is ultimately the intention.
Interest rates are determined by benchmark rates set in large by the Federal Reserve. Banks use this as a guide for what interest rates to charge you for your loan. There is not one set rate, and other factors — such as your current credit score and history — play a part in deciding your rate and how much you will ultimately pay.
What Are Benchmark Interest Rates?
As aforementioned, benchmark rates are the standard set for interest rates when loaning or borrowing money. This standard is used in many areas of debt, both business and personal. Benchmark rates are used as a guidepost for how high interest rates should be, as well as the frequency with which banks lend money.
Who Is Raising Interest Rates?
Even with the best of intentions, it can still feel like the government is sometimes putting your finances in an unnecessary pinch. When it comes to raising interest rates in the United States, the buck of responsibility stops with the Federal Reserve. The committee that resides over the Federal Reserve and makes the call to raise or lower interest rates is the Federal Open Market Committee (FOMC). It can change interest rates and often does so to support economic growth or stave off economic recession.
Interest rates are not just going up domestically, but also globally. When it comes to setting benchmark rates, the Federal Reserve has the largest influence. The two main benchmark interest rates are the federal funds rate and the London Interbank Offered Rate.
Federal Funds Rate
The federal funds rate’s job is to affect monetary policy. It is determined by FOMC and is the target rate on which banks base their interest when loaning to customers, businesses or other banks. The current federal funds rate is 3.75% to 4.00% which indicate the minimum and maximum value.
London Interbank Offered Rate
In the global economy, the London Interbank Offered Rate, or LIBOR, plays a role in setting the benchmark rate for loans in markets around the world. When the biggest banks in the world need to borrow money from each other, the interest rate at which they do so is based on the LIBOR rate. This rate is considered the median rate based on these global banks and financial institutions.
When Will Interest Rates Come Down?
As inflation increases and is still oppressing the rate at which people spend, so go the interest rates. Unfortunately, it is estimated that rates will be increased once more in 2022. FOMC meets in December and is projected to raise interest rates by 0.5 percentage points.
It is also estimated that interest rates will continue to rise in 2023, but not at the frequency they did in 2022. It is not as comforting as reading the rates will go down, but it is better than nothing.
Where Should You Invest When Interest Rates Go Up?
When it comes to the economy, everything is related. Inflation affects interest rates which affect investments. This is not to say store your money under a mattress, but it is good to know how some of the ways in which you invest could be impacted when interest rates go up.
Such investments as fixed-income investments, equity investments or savings accounts can be differently influenced by rising interest rates.
Fixed-income Investments
Fixed-income investments are considered a less risky investment, since the bond price is based on the interest rate the bond pays and not necessarily the growth rate of the company. When possible, make sure to invest in the shortest duration bond available. When interest rates are high, you may lose money by investing in a longer-duration bond if you have to sell before the bond matures.
Equity Investments
Where fixed-income investments are a bit safer, equity investments are a bit riskier. The stock market often takes a dip when interest rates go up. Large companies tend to fare better, while smaller companies with high-growth stocks plummet the most.
Savings Accounts
The good old savings account. When something is created for a rainy day, it is always good to check the weather. One of the few perks to high interest rates is that they also go up on the interest on a savings account or certificate of deposit.
Why Are Interest Rates Rising?
So, why are interest rates rising? The simplest explanation is that interest rates are going up because of inflation. The Federal Reserve increases interest rates to slow down inflation by slowing down economic growth. It is projected that this trend will continue throughout the rest of 2022 and into 2023.
Final Takeaway
Inflation is taking a toll on the economy, there are no questions about it. Everyone is struggling with it, from families to corporations. Experts say raising interest rates is the way to combat the inflation monster, but at the end of the day, it doesn’t make milk any less expensive.
FAQ
What is the Fed interest rate today?
After a fourth consecutive rate hike by 0.75 percentage points, the current Federal Reserve rate, or federal reserve funds rate, is 3.75% to 4.00% as of November 2022.
Are interest rates going up in 2022?
It is estimated that at the next meeting of the Federal Reserve in December 2022, there will be a 0.5 percentage point increase in interest rates.
What is the date of the next Federal Reserve meeting in 2022?
The next meeting for the Federal Reserve, which is held by the Federal Open Market Committee (FOMC), is slated to take place from Dec. 13, 2022, to Dec. 14, 2022.
Are interest rates going up in 2023?
It is estimated that interest rates will continue going up throughout 2023. Though they will be increasing, they will not increase as rapidly as they did in 2022.
Information is accurate as of Nov. 14, 2022, and is subject to change.
This article originally appeared on GOBankingRates.com: Why Are Interest Rates Going Up? What Investors Need to Know
