There's a good chance you've seen a headline about the Federal Reserve raising interest rates in the last few months. But what does it mean to raise rates, why are they being raised, and what impact can rising rates have on you as a consumer?
The Rundown on Rates
Central banks around the world have several levers they can push and pull to manage economic growth, and one of them is interest rates. In the US, the Federal Reserve (Fed) sets the federal funds rate, which is the rate at which financial institutions can borrow from each other. Since this is the rate banks pay to borrow money, it ultimately trickles through to consumers.
For example, to encourage growth during the financial crisis in 2008, the Fed pushed the rates lever all the way to the floor. The Fed dropped the federal funds rate to near zero to incentivize lending by making it cheap for consumers and businesses. As a consumer, that's why the interest rate on your savings account hasn't been very impressive. But it's also why borrowers got a break: the rates on loans, such as mortgages, reached record lows.
The End of the Low-Rates Decade
Now that the economy has gotten back on its feet, the Fed is ready to start pulling the rates lever back toward normal. The Federal Open Markets Committee, or FOMC, meets quarterly to review economic progress, unemployment trends, inflation, and a few other key measurements, and set the federal funds rate. With steady growth and marked improvement in the jobs market, they think it's time to ease back on easy money.
If the underlying rate that ultimately influences mortgage, credit card, and other loan rates is going up, won't that mean borrowing is more expensive for consumers? The answer is yes, but it's important to note that the FOMC has very clearly stated that it plans to move gradually. The current conventional wisdom is that the Fed will raise rates two to three times in 2017.
What to Keep in Mind
Equally important to keep in mind, the Fed wouldn't raise rates unless they believed the economy was stable enough to handle it. It's taken years for the economy to become healthy enough for the Fed to feel comfortable raising rates. And rates have a long way to go to return to normal levels; as of the time of this writing, rates were less than 1%, while the long-term average is closer to 5%.
Rising Rates and You
In short, it's a positive sign that the Fed is comfortable normalizing interest rates. If you're a saver, this should eventually be a benefit to you as savings and money-market accounts provide higher yields. But if you're a borrower, rising rates may be less welcome because obtaining loans will become more expensive.
As interest rates continue to normalize, there may also be impacts to your investment portfolio, which we discuss in more detail in "Why Rising Rates Can Be Good For Your Portfolio." If you'd like to better understand how rising rates may impact you individually, schedule time to discuss with your financial advisor.
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