What Does The Fed’s Interest Rate Hike Mean For Me?
The average consumer is already going through a great deal, as prices of various products continuously increase due to inflation. Supermarket items, gasoline, and other necessities grow more expensive by the day. Inflation is, unfortunately, here. The cost of living is growing costlier by the day. Money is losing value, and everyone takes the hit—unless you have created protections for yourself and your family.
This is where the Federal Reserve intervenes and attempts to control inflation through interest rates. It’s actually a pretty simple concept: the higher the federal funds rate, the higher the borrowing costs. The Fed’s actions prevent borrowing, subsequently lowering demand and thus reining in inflation.
The Federal Reserve is expecting to continue rate increases as we go deeper with this year. Consumers are the driver of our economy and definitely the primary recipients of the effects of price hikes. To prepare yourself accordingly, MAC Assets created a simple guide on the meaning of the federal interest rate rise.
What does the half-point rate hike mean for the average consumer?
The federal funds rate is the interest rate that is applied when banks borrow and lend. This rate is set by the central bank. After a two-day meeting, the Federal Reserve officially raised the federal funds rate by a half-point last Wednesday, May 4, 2022.
This is a significant increase since the market has not seen this substantial a hike in the last 20 years. The reason for such, according to Greg McBride, a chief financial analyst, is because the Federal Reserve is “behind the curve and they need to raise interest rates a lot and in a hurry.” In the process, the Federal Reserve hopes to prevent inflation and keep the vulnerable economy as stable as possible. Here are the 4 main effects of the interest rate rise.
Increase the cost of capital for purchases
As the Federal Interest Rate increases, the cost of borrowing increases. This is because the other rates in the economy are tied to the federal funds rate, thereby causing a direct effect on the way consumers pay.
- Carrying a credit card balance
- Taking out a loan
- Cost of capital for multifamily acquisitions
- Yields of savings accounts
- Certificates of deposits
- Higher costs for purchases
Slow demand from purchasers
The federal interest rate hike slows down the demand from purchasers, theoretically because they have less money to spend since they have to shoulder the higher interest rate. Accordingly, spending and demand slow down.
Increased or higher costs tend to also cause purchasers and business owners to postpone projects that require major financing. This seemingly harmless increase actually has a lifetime impact. A $300,000 30-year fixed-rate mortgage offered at 3.5% interest will result in a monthly payment of $1,340. However, if that loan is taken after the hike, the interest rate becomes 4.5% which amounts to $1,520 per month or an increase in cost for the new homeowner of 12%. The effect, over time, is that greater cost will slow demand for those who cannot afford the increases.
Drive down inflationary pressures
The primary goal of the federal interest rate increase is to contain inflation by decreasing spending at both the consumer and business levels. This is achieved when the cost of borrowing increases, thus disincentivizing people to spend. However, the central bank is hoping that the effects will be limited to taming inflation without going to the extent of recession. Over time, the Fed has been unsuccessful in this delicate balancing act and we are unsure what will occur this time…as the experts say, “stay tuned.”
According to the Fed’s gauge, inflation reached 6.6% during April—unfortunately, this is the highest point in 40 years. Our current predicament is caused by robust spending, and supply bottlenecks from COVID’s long tail combined with higher food and gas prices triggered by the Russia-Ukraine conflict. Policymakers are considering a higher benchmark rate and tighter credit if the recent hike proves to be ineffective. It does appear that guidance suggests continued hikes throughout 2022.
This interest rate hike means that the market is evolving, with no clear direction at the moment. This may feel daunting for some but it is actually the perfect time to strike. It is up to investors to pick a course and run it. This generates a lot of opportunities for investors all over the globe.
More specifically, investors can take advantage of financial leverage as a hedge against both inflation and further rate hikes. This yields exponential returns that can be used to keep up with increasing prices, not to mention a way to keep your cash deployed and not becoming, as Ray Dalio writes, “Cash is trash.”
Why is real estate a hedge against inflation?
Real estate works well with inflation simply because property values rise with inflation. As such, the property owner can justifiably charge higher rent to keep up with the economy, therefore resulting in higher net operating income.
Inflation also directly affects debt by lowering the loan-to-value equivalent of mortgage debts, serving as a natural discount. Property equities may rise but the payments remain at a fixed rate.
Real estate investors will benefit in particular, especially from short-term lease assets like multi-family holdings. There is also a noticeable historic trend that real estate values follow a steady upward curve. For example, properties that hit rock-bottom prices during the downturn in 2008 were stabilized to their pre-crash prices by 2010. This area is an excellent source of recurring income to shield investors against the rising inflation costs.
MAC Assets recommends investing in multi-family properties to use real estate to hedge against the rising inflation. Multi-family acquisitions are always in demand and have a relatively higher turnover rate, with multilateral opportunities to generate income. Contact MAC Assets today for more information. Make sure to check out the other blogs on our site for more information and sign up for our monthly newsletter here.