After years of crisis-era zero interest rates, the Federal Reserve recently raised its key interest rate by 0.25% for the second time in just three months. After the quarter point rate hike, the Fed Funds Target Rate now stands at 1.25%, which is still very low by historical standards. In doing so, the Fed is signaling its confidence in the economy, which is modestly growing.
However, was this most recent hike a wise decision? Some economists fear that the Fed may be raising rates at a faster pace than the economy can withstand.
In this year’s first quarter, the economy grew at a marginal 0.7%, its weakest in three years. In May, retail sales were down 0.3%, a much steeper decline than the 0.1% economists predicted. Because consumer spending accounts for more than 2/3 of the economy, a downturn could be a sign of trouble ahead for the economy.
Changes in interest rates can have both positive and negative effects on the U.S. markets. When the Federal Reserve changes the rate at which banks borrow money, this has a ripple effect across the entire economy. Higher interest rates mean that consumers don’t have as much disposable income and must cut back on spending. It’s important to remember that we’re a consumer-based economy, so first and foremost the sign of a healthy U.S. economy is if the consumer is out in the marketplace spending on goods and services.
Conversely, as the Fed continues to raise rates throughout the year, higher mortgage rates will follow. Often the prospect of higher mortgage rates compels consumers to purchase property. Higher mortgage rates could push potential property investors off the fence – increasing demand, increasing prices and increasing equity.
In addition to the above examples, interest rates affect the economy by influencing stock and bond interest rates, consumer and business spending, inflation and recessions. The bottom line is that we need to be sure that we are making smart investment decisions across the board. By understanding the relationship between interest rates and the U.S. economy we can more clearly decipher the bigger picture enabling us to make the best decisions possible.