This week, the Federal Reserve is in the news with a shakeup that may usurp current Chairwoman Janet Yellen as agency head. But that’s not the only headline about the Federal Reserve, the central bank in the U.S. that dictates so much about the ebb and flow about our economy, as rate increases are once again on the horizon. This week, the Federal Reserve is in the news with a shakeup that may usurp current Chairwoman Janet Yellen as agency head. But that’s not the only headline about the Federal Reserve, the central bank in the U.S. that dictates so much about the ebb and flow about our economy, as rate increases are once again on the horizon.
However, before you start lamenting a Fed rate increase as a death knell for low mortgage interest rates, there’s much to learn and consider. In fact, the Fed has already bumped their Fed funds interest rate twice this year, on March 15 from and then again on June 14, from 1.0 to 1.25%.
In 2016, we saw a Fed rate nudge in December from a range of 0% to 0.25% to a range of 0.25% to 0.5% – a quarter-point increase. It was also the first Fed rate increase since 2007, as the government’s central bank aimed to kick-start the economy to drag us out of a recession. But before that, in between 2004 and 2007, the Fed raised the fund rate seventeen meetings in a row!
We expect another Fed rate increase this year – possibly at the end of the year but, so far, these increases have been met with words like “measured,” “gradual,” and “healthy” among analysts – and could be a lot more positive than negative news.
First, a little background. What’s commonly referred to as the “Fed rate” or “Feds raising rates” actually references the federal funds rate. It’s the interest that banks and other financial institutions pay when lending money to each other, usually on an overnight basis. Therefore, it’s raised and lowered to act as a faucet to turn on and off the flow of funds and lending by influencing interest rates.
Remember that the Federal Reserve doesn’t set interest rates for lending, banks, and commerce directly, but the major indexed rates, like the widely used prime rate, mirror it almost identically. So a rise in the federal funds rate means we’re going to see a corresponding increase in the prime rate, which is the base rate that money may be lent out commercially. And the prime rate does dictate the interest rates we use every day, such as APRs on credit cards and adjustable mortgages.
So why did the Fed increase its rate? As we mentioned, the Fed benchmark rate was set so low when the country was in crisis mode that there was nowhere to go but up. But the Fed also raises the rate to ease inflation as the economy grows. The Federal Reserve is encouraged by strong jobs and unemployment numbers; both main indicators. Therefore, a gradual increase is seen as pivotal to our long-term economic balance and health.
Sure, mortgage interest rates are expected to increase gradually – but that was inevitable since we’ve had an unparalleled run of historically low rates.
Here are 10 ways Federal Reserve rate increase can be a positive thing:
1. A Fed increase doesn’t mean a mortgage rate increase
When the average consumer hears about a Fed rate hike, they may think that mortgage interest rates are set to rise. But the Fed increases their Fed funds rate, which is far different than mortgage interest rates. While there is some direct influence between our banks, lending institutions, and governmental policy, mortgage rates are influenced by far more factors in the economy than just this Fed decision.
2. Higher savings rates for consumers
Although banks didn’t immediately respond to the news with savings rate increase, eventually, consumers will see an increase in their return on savings. In fact, average 1- and 5-year certificates of deposit have paid less than 1% interest since September 2012, an unprecedented period of infinitesimal returns. But once again, savers may be encouraged to make deposits and park their money with banks.
3. Signs of economic prosperity
The increase in rate is a long-awaited signal that the U.S economy is booming or, at the very least, running at full steam. Tracking the last decade of rate increases (or lack thereof), we see that the Fed set interest rates near zero percent in December of 2008 to help stimulate borrowing and keep the housing, mortgage, and banking systems from completely failing. But now, unemployment is low, the stock market is higher than ever, and the business economy is thriving. Basically, a slight rate increase means things are cooking everywhere else in the economy.
4. These rate increases aren’t unexpected or unwelcomed
Through the last several rate increases, Fed chief Janet Yellen couldn’t have prepped the country and softened the blow anymore even if she wrapped it in a pillow and served it up on a puffy cloud. In fact, this past rate increase was largely expected, and the language of the Fed – such as statements that we’ll only see “gradual increases” in rates and they will remain low “for some time” – is a sign of stability, not volatility.
5. Rate increase balance against inflation
The Fed largely lowers their benchmark rate to temper inflation, but they’re still a little puzzled why inflation growth is so slow. In fact, their target is an inflation rate of 2%, and as of September, we’ve finally surpassed 2%, reaching 2.2%. But that’s the first time we’ve seen an inflation rate over 2% all year, and a Fed rate increase is one way to make sure to cool off growth that’s too quick or too high (preventing more bubbles in real estate or the economy).
6. The stock market responds well
The Dow is booming, the NASDAQ is jumping, and Wall Street is thriving more than ever. And the stock market has also not shied away from these rate increases, rallying on news of gradual and slight rate bumps. Usually, the markets suffer whenever volatility or negative economic news comes in place, but the Dow’s reaction signals that investors are comfortable with a smooth ramp towards rate normalization – not a cliff.
7. Loosening lending standards
Sure, it’s possible that mortgage interest rates will rise a little over the next year or two, but they still remain well below historical averages. But you should also remember that low rates are just one part of the lending and mortgage equation. With slightly higher rates will come more stability and less risk for investors, so banks and financial institutions are expected to keep easing the lending parameters and rolling out nonconventional loans, such as those for buyers who have less money to put down on a house. A loosening of the credit markets is expected to be a boon to the tens of millions of would-be homebuyers who have the income to buy, but not the down payment.
8. More interest income for retirees
Senior citizens, retirees, and the Boomer generation are expected to benefit from the rate hike, as a significant part of their savings and investments may be in financial vehicles like CDs, bonds, etc. that are paying paltry returns now, but will increase soon.
9. The U.S. dollar will be stronger abroad
This move will have a ripple effect on the value of the dollar abroad, welcome news to travelers, American investors in foreign markets, and our economic position worldwide. Maybe it will be time take that dream vacation abroad soon if our dollar stretches farther?
10. Consumers with high credit scores will benefit
People with high credit scores will be big winners as the dust settles, still able to take out the best rates on mortgages, credit cards, auto loans, and even shop for fixed-rate products that aren’t tied to prime – or impacted by the Federal funds rate.
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