Federal Reserve Announced Interest Rate Hike
- On Wednesday, May 4, 2022, the Federal Reserve Bank announced they would be raising interest rates by a half-point.
- Their reasoning behind the increasing interest rate is to reduce consumer spending and inflation.
- As the interest rate rising causes lower levels of consumer spending, many have begun liquidating their shares, resulting in the S&P 500 dropping 3.5% one day following the announcement.
On Wednesday, May 4, 2022, the Federal Reserve Bank announced they will be raising interest rates by a half-point. The rising rates have been at their highest point in more than 20 years, and the increased rates have caused the stock market to go into a frenzy, with the S&P 500 dropping by 3.5% the following day.
Reasoning Behind Interest Rate Hike
When asked about the rising rates, Fed Chairman Jerome Powell said, “Inflation is much too high, and we understand the hardship it is causing. We’re moving expeditiously to bring it back down.” The meaning behind this quote is when interest rates increase, borrowing costs go up, making it less appealing for people to take out loans for major financial decisions, such as purchasing a house.
Consequently, the Central Bank is taking measures to ensure the financial system does not spiral out of control by raising the cost of borrowing.
Impacts of Interest Rate Hike
Increasing interest rates have helped combat inflation in the past, and below are some of the outcomes after increased interest rates.
Higher Mortgage Rates
One of the main issues the higher interest rates cause is higher mortgage rates for those in the process of purchasing a house or while repaying their loan. However, one important thing to note is that homeowners with a fixed rate repaying their mortgage will not be affected by this change in the interest rate, as their rate remains the same for the duration of their repayment period.
However, homeowners who have a variable rate in their repayment plan may have to pay more as a higher interest rate causes their monthly payments to rise in value. Consequently, the higher interest rate results in lower disposable income for these homeowners, but this can be resolved by going to their local bank and attempting to refinance their mortgage.
Less Consumer Spending
The primary purpose behind the increase in interest rates is to lower consumer spending. However, due to the lockdowns in China, significant supply chain issues are going on as there are many restrictions, resulting in lower production. The supply chain issues would cause an increase in price as there are fewer goods on the market.
Nevertheless, the increased interest rate will most likely counteract this supply chain issue. As people are less willing to purchase goods at a higher price, companies must lower their prices if they wish to increase the number of customers who purchase their products and services.
How to Counter Interest Rate Hike
Consumer spending will most likely drop with interest rates rising, meaning people will have more disposable income. Due to the higher disposable income levels, here is one primary way to use the increasing interest rates in your favor.
Invest in the Stock Market
Every little bit helps because the stock market usually increases in value each year. However, as the stock market has experienced heavy fluctuations since this announcement, many investors have begun to panic and sell their stocks as they wish to retain liquid assets during this time.
Consequently, as many people are selling, many stocks are undervalued and can be quite profitable if sufficient research has been done on the company and its financial position.
Furthermore, if the stocks being traded are held until retirement, the best way to invest in the stock market is by opening a Roth IRA account. Although other IRA accounts can be opened when planning for retirement, a Roth IRA account is ideal when investing in the stock market.
As the money deposited into a Roth IRA account is from after-tax dollars, any profits earned from investments cannot be taxed by the government again.
However, be cautious when investing in the stock market as it can be unpredictable, and it is essential not to listen to anyone’s financial advice before doing your own research. One example of how the stock market can be challenging to anticipate is the global housing crisis in 2008 and the beginning of the COVID-19 pandemic.
These economic setbacks demonstrate that the stock market typically increases in the long run, but there will be times when the market, in general, loses money. Thus, it is crucial to keep this in mind when determining how much you will invest and in which sector.
It is too early to tell whether the short-term increase in the interest rate will benefit the economy. However, there has been speculation that the Central Bank may be looking to increase interest rates by another half-point sometime in June as well to minimize inflation.
Disclaimer: The mentioned remarks regarding countering the interest rate hike are not considered financial advice. It's critical to do your due diligence prior to investing in the stock market. CapWay is not liable for any losses made from investments based on the above information.
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