On Wednesday, the Federal Open Markets Committee announced that it had unanimously voted to raise the federal funds rate (the rate at which commercial banks borrow and lend reserves) by 75 basis points for the fourth consecutive meeting, to a target range of 3.75% to 4% from the current rate of 3.25 to 3%.

The Federal Reserve put these measures in place to moderate the country’s multi-decade highs in inflation by driving up borrowing costs. The action was implemented to suggest that the Federal Reserve would soon ease off on its most draconian economic tightening program in three decades.

According to data from the Consumer Price Index, the annual inflation rate has remained persistently high in the U.S., only declining from a peak of 9.1% in June to 8.2% as of September. That is much higher than the preferred inflation rate of 2% set by the central bank.

How is the stock market reacting?

Some mortgage rates have nearly doubled, indicating that the housing market is currently in a slump. The 30-year fixed-rate mortgage stood at 7.08% in the week of October 28, up from 3.85% in March, according to Freddie Mac.

The S&P 500 fell 2.5%, while the Dow Jones Industrial Average lost 500 points, or 1.6%. The heavily tech-focused Nasdaq Composite dropped by 3.4% (Yahoo Finance 11/2022).

Following the announcement, stocks initially rose but lost momentum as Fed Chair,  Jerome Powell insisted it is “premature” to consider a pause on rate hikes in his post-meeting press conference, dismissing the concept of a policy pivot in the near future. The Fed still has a “ways to go” according to Powell, who also predicts that “the ultimate level of interest rates will be higher than previously expected.”

A change in the interest rate typically takes at least a year to have a significant impact on the economy, however, the stock market tends to react to changes sooner; markets customarily set prices that factor in potential rate hikes in anticipation that the FOMC’s actions will be made official.

Here’s what we can expect

There is only one more policy meeting for the Fed this year, which concludes on December 5. A half-point rate increase will be made in December, followed by a quarter-point increase in January, according to Goldman.

By raising its benchmark federal funds rate, the Fed increases the cost of borrowing for consumers. Higher interest rates deter economic expansion, which can lead to a recession in which many people already struggling with rising costs would lose their employment.

According to 14 economists surveyed by financial services website Bankrate, the economy will contract in the next 12 to 18 months with a 0.67 probability. As reported by a study conducted at the beginning of the year, this is an increase from a 0.3 probability. More pessimistically, a Bloomberg probability model predicts a 100% possibility of a recession by October 2023.

According to predictions made by the U.S. central bank, rates would peak at 4.5% to 4.75% in 2023. The Fed is anticipated to increase its benchmark rate even further by March 2023, to a range of 4.75% to 5%, according to Goldman Sachs economists, implying that interest rates will continue to rise, making borrowing more expensive overall.

What does this mean?

Consumers should anticipate higher fees for a variety of debts as interest rates rise (according to Greg McBride, Chief Financial Analyst at Bankrate):

1. The annual percentage rate (APR) on credit cards is anticipated to increase, reaching an average of 19% from 18.16% as of late September.
2. For new auto loans or auto loans with variable-rate financing, we expect higher interest costs; the typical interest rate for a 60-month loan on a new car will likely rise to 6% from its current rate of 5.63%.
3. Mortgage interest rates typically increase along with rate increases, but the bond market has a more direct impact on them. If inflation remains high or increases, the rate for 30-year fixed mortgages might increase from slightly over 7% to 7.25%.
4. The rate hike will probably result in an increase in interest rates on variable-rate loans including home equity loans and home equity lines of credit (HELOC). These loans currently have average interest rates of around 7.3%, but they could increase to an average of 8% in the future.

The silver lining: following several rate hikes, savings account interest rates in the U.S. are now higher. While the Fed has no direct control over deposit rates, they are often concurrent with changes in the target federal funds rate. At some of the leading retail banks, savings account rates, which have been at historically low levels for the majority of the COVID-19 pandemic, are currently up to an average of 0.21%. Top-yielding online savings account rates are as high as 3.5%, far higher than the average interest from a conventional, brick-and-mortar bank (this is due in part to fewer administrative costs.)

The fixed income securities market experiences a rise in interest rates when the Federal Reserve raises the federal funds rate; both domestic and international investors find higher yields more appealing. Global investors are encouraged to sell investments denominated in their own currency in exchange for dollar-denominated fixed-income securities issued by the United States. As a result, demand for the greenback rises, resulting in a stronger exchange rate in favour of the U.S. Dollar.