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Review of all things Real Estate: Effects of the Fed raising the federal funds rate…again

Bob Hillery

CR Properties

The Federal Reserve announced it is raising interest rates by 0.25 percentage points following its March 21-22 meeting, bumping the federal funds rate to a target range of 4.75 to 5.0%. With the move, the Federal Reserve marked the ninth straight meeting that it raised rates aiming to rapidly reduce liquidity in the financial markets and tamp down high inflation.

The Fed’s decision comes as inflation hit 6% year over year in February, still among the highest levels in decades though falling from its 2022 highs. With the Fed continuing to hit the brakes on an overheated economy, the main question is how much further the Fed will raise rates and how deep an ensuing recession could become.

Besides raising interest rates, the Fed has also been selling off huge chunks of its bond portfolio. As the Fed runs off its balance sheet, the move helps drain liquidity from the financial system into slow inflation.

As the Fed continues to raise rates, here’s a brief outline of the positive and negative impacts of the latest increase.

Savings accounts and CDs

Rising interest rates mean that many banks will offer rising returns on their savings and money market accounts. Savers looking to maximize their earnings from interest should consider turning to online banks or the top credit unions, where rates are typically much better than those offered by traditional banks.

When it comes to CDs, account holders who recently locked in rates will retain those yields for the term of the CD, unless they’re willing to pay a penalty to break it.

Mortgages

With the 10-year Treasury yield falling from its highest levels in recent months as the market braces for a potential recession, mortgage rates have fallen a bit. But mortgage rates remain well above where they were a year ago, which following the rapid rise in housing prices over the past couple of years has created a double crunch for potential homebuyers.

Home prices are more expensive, as are mortgages, resulting in a slowdown in the housing market (except here in Fallbrook and most of North County...for now).

The cost of a home equity line of credit (HELOC) will be creeping higher since HELOCs adjust to changes in the federal funds rate. HELOCs are typically linked to the prime rate. Those with outstanding HELOC balances will see rates increase.

Stock and bond investors

The stock market soared when the Fed kept rates at near-zero. Low rates were beneficial for stocks, making them look like a more attractive investment in comparison to paltry rates on bonds and fixed-income investments such as CDs.

For most of 2022, higher rates hit bonds hard, pushing their prices down. The longer the bond’s maturity, the more it’s been stung by rising rates. However, with investors sensing an end to the Fed’s aggressive tightening, the bond market has been finding a floor in prices. But with the economy yet to endure an expected recession, stocks could be in for a bumpy ride.

Borrowers

If you’re an existing borrower and you locked in a 30-year fixed-rate mortgage in 2021 or 2022; you’re in decent shape. But anyone else looking to access new credit (mortgages, credit cards, student loans, personal loans, auto loans); it’s going to be more expensive to borrow.

Floating-rate debt is also subject to higher rates. Adjustable-rate mortgages taken out years ago may be resetting at higher rates and pushing up your monthly payment.

Credit cards

Many variable-rate credit cards change the rate they charge customers based on the prime rate, which is closely related to the federal funds rate. The Fed’s decision means that interest on variable-rate cards will move higher even though rates on cards are already at multi-decade highs and are still rising.

Rates on credit cards are largely a non-issue, if you’re not running a balance.

The U.S. federal government

With the national debt nearing $32 trillion, rising rates will raise the costs to the federal government as it rolls over debt and borrows new money. The government has benefited for decades from the decline in interest rates. While rates might rise cyclically during an economic boom, they’ve been moving steadily lower over the long term.

Bottom line

Inflation has been running hot over the last couple of years and the Fed is aggressively raising interest rates to combat it. I recommend checking with trusted advisors (CPA, financial advisor, bartender) for additional methods to combat the effects of high inflation. In my mind, the best solution is disciplined fiscal policy with slow-to-react monetary policy. The government needs to spend less, that will bring down inflation.

 

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