When it comes to managing the economy, few people have as much influence as our Federal Reserve. The Fed controls a key interest rate that has a massive impact on the cost of borrowing, including mortgages, auto loans and credit cards. It’s a bit like the Goldilocks tale: The Fed aims to raise and lower rates by just the right amount to support employment levels while supporting price stability.
When the Fed raises interest rates, it makes it more expensive to borrow money. Consumers will likely pause spending in anticipation of higher rates, potentially decreasing demand and reducing inflation. In addition, interest rates rise when investors move their funds into higher yielding investments, such as bonds. Investing in bond instruments can provide a more stable return, and is typically more liquid than stocks.
As for businesses, higher interest rates cut into profit margins by increasing their financing costs. In addition, businesses that require a large amount of fixed-rate capital may find it difficult to compete with foreign companies that are able to finance projects at lower interest rates.
Aside from the potential to reduce demand, a rising rate environment may benefit savers by incentivizing banks to offer higher returns on savings accounts and other deposit products. This can help consumers increase their wealth faster. For borrowers, however, this may mean it will take longer to pay off debts or rebalance their portfolio as the costs of borrowing rise. As such, it’s wise to talk to your financial advisor about the effect of rising interest rates on your finances.
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