It was one year ago that the target range for the federal funds rate was between 0% to 0.25%. And now we are experiencing the highest level of price inflation in 40 years. The target range for the federal funds rate is currently between 4.25% to 4.5%.
Well, your savings rate went up again, which is a good thing! But that increase in no way offsets the increase to mortgages, home equity loans, personal loans, business loans and even car loans. Guess the rate increases are a good way to balance the chip issues with new automobiles, and supply issues on construction materials for new homes and remodeling projects, to name a few big ones. But that is what the interest rate hikes intend to do – curb inflation by making borrowing more expensive and slowing down spending. And even though inflation has slowed in the past two months, people are still spending, at a slower pace albeit. So, the economy is making progress in the right direction. Slowly…
Experts are predicting inflation to fall to 3.5% in 2023, which is still higher than the 2.0% inflation rate that the Federal Reserve would prefer for our economy. So don’t be surprised by more interest rate hikes in 2023. And the slowing of the economy could result in a possible recession in 2023. Many experts believe that it will take another 12 to 18 months to trend towards a more normal pattern, whatever normal means these days….
As for adverse effects from interest rate hikes, I have already mentioned one. Lending rates have gone way up in the past 12 months. Long gone are the days of obtaining mortgage rates less than 3.5%. Consequently, there has been a significant cool down in home sales in much of the country. Those who are still interested in buying a home cannot afford as much of a home now as they could afford a year ago which is pricing them out of the market. If you have cash to purchase a home, this may be an ideal time to buy as you can negotiate a good price on a home in a ‘noncompetitive’ market. Bear in mind that home sales are still doing well in competitive markets/neighborhoods.
Instead of dwelling on the adverse effects from interest rate hikes, let’s look at a positive impact from those rate hikes. And that would be interest rates you can get on Multi-Year Guaranteed Annuities (MYGAs) and even Certificates of Deposit (CDs). We may not experience rates as high as they are today even in 2023, especially if inflation is expected to fall to 3.5% in 2023. If you have extra cash sitting aside that you don’t need access to for three to five years, put your money in a MYGA where rates are around, if not greater than, 5%, compounded annually! Bear in mind that many MYGAs offer up to 10% annual withdrawals, penalty free!
What about the impact of interest rate increases on the market for stocks and bonds? There is a correlation between stock and bond prices and interest rates. Bond prices have an inverse relationship with interest rates. In other words, if interest rates go up, bond prices go down. Think about it, if you are holding a bond with a lower interest rate in a rising interest rate environment, you want to sell it for a bond that pays a higher interest rate. Therefore, the price of your bond is lower than a new bond since investors want to purchase bonds with a higher interest payment than what your bond offers. Bonds paying higher interest rates are even more valuable if the interest payments are reinvested in the bond fund (i.e. compounding).
As for stocks, high inflation can have many impacts on public companies’ earnings in addition to general impacts on the stock market. I mentioned previously that borrowing is more expensive when interest rates go up. That can impact a companies’ bottom line, even dramatically if the company needs financing to grow its business or even to maintain the vitality of the business during tough economic times. And we are looking at a possible recession in 2023.
A general slowdown of the economy due to high inflation, regardless of how a company is performing, can also put downward pressure on stock prices. And that is exactly what is happening. Companies are still paying high dividends and making lucrative capital gains distributions in 2022 despite their stock price being down this year. Now will that be the same story for 2023 given the pressure that high interest rates are having on companies in addition to more expensive goods and services? It will be interesting to see what happens in 2023.
As for the stock market, this is the time to invest! To reap the rewards in the LONG TERM!! If you are investing for short term gains, precede with extreme caution. If you have extra cash sitting around, invest during the slowdown of the economy. There are many companies who are currently undervalued and would make great deals for you to purchase.
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