Higher interest rates and what that means for you
Higher interest rates and what that means for you
Written By Gurpreet Jagpal
Economist after economist has raised their forecast for the year, especially given where inflation is hurting. Jerome Powell indicated that the Federal Reserve will taper its bond buying program. Last weeks Fed meeting also suggested that a rate hike at their march meeting is very likely.
Interest rates were near rock bottom because of the pandemic. When COVID first took over our lives in March of 2020, The Fed lowered Interest rates to help keep the economy going. Lower interest rates help keep borrowing low, so credit is cheap and that help stimulate the economy. Those record low interest rates have now sparked a hyperinflationary environment.
Investment bank after investment bank is raising their target rate hike(s) that are needed to tame inflation. Goldman Sachs thinks five rate hikes are needed while Bank Of America thinks seven rate hikes are needed. If Bank Of America’s prediction holds to be true, then that means a rate hike at each of the remaining Fed meetings left in 2022. Those rate hikes bring the Federal funds rate to 1.75% to 2% by year-end.
The Federal Funds rate is a target interest rate that the Fed requires banks charge for overnight loans. Depending on what happens during the day at a bank, if a bank is below its threshold it should have for cash holdings it will borrow money overnight to meet those requirements. The overnight borrowing is what the 1.75% – 2% I have mentioned above.
Risk assets such as stocks are vulnerable to wild swings. Higher rates can signal a stronger economy, but this time that isn’t necessarily the case. Rate hikes are needed this time to tame runaway inflation. The Russel 2000 might be a beneficiary of a stronger economy, but since this is to tame inflation the Russel 2000 is vulnerable. High growth technology stocks are also at risk because of their high P/E multiples.
Financial stocks such as banks (Wells Fargo, Bank Of America, Citi, JPMorgan) can benefit from higher rates. They borrow money at a lower interest rate and lend it to us (The consumer) at a higher interest rate. They make money on the spread of the two interest rates.
Companies that have a bulk of their sales outside of the U.S. can be impacted. Repatriation of that cash will be more expensive. When the dollar is weaker that is a more favorable environment for companies to bring their cash from other currencies and convert them to the U.S. dollar.
Higher interest rates strengthen the U.S. dollar, so sending money out of the United States can be favored. If the exchange rate between the U.S. dollar and the Indian Rupee is $1 = RS. 75, a stronger dollar would mean maybe $1 = RS. 80 (This is just an example, and is not specific to the Indian Rupee).
When I wrote that repatriation of the cash in to the U.S. by companies that have sales outside the U.S. will be more expensive… I hope you can see why. It will take a higher exchange rate from the foreign country into the U.S. leading the company to less money in terms of dollars.
Stronger dollar can reduce the price of commodities like gold and silver. I am very hopeful that the stronger dollar can reduce the price of oil, giving consumers relief at the pump.
Markets typically do not like higher interest rates. When interest rates rise this decreases the value of bonds held currently by bond investors. Also, higher interest rates make stocks a less attractive investment because you are getting a higher yield on a much safer investment in bonds.
Higher interest rates of course means that credit card debt will be higher. For those carrying credit card balances those balances will be more expensive to carry. Higher rates means higher payment of interest.
Higher rates can also lead to higher mortgage payments (if you have an adjustable loan). Many of us have been dying to see home prices go down. Increased mortgage rates can help curb the high home prices, but it may not be a very significant impact.
