The global economy is in trouble and all eyes were looking in one direction — the United States of America. On Wednesday, the Federal Reserve raised interest rates again, despite fears that the move could add to financial turmoil after a string of bank failures.
The US central bank increased its key rate by 0.25 percentage points, to a range of 4.75 per cent to five per cent, its highest level in 16 years. This marks the ninth consecutive increase in one year since the US central bank began the current rate-raising cycle to combat rising prices
While announcing the rise in interest rates, Federal Reserve chairman Jerome Powell said the Fed remained focused on its inflation fight. He described Silicon Valley bank as an “outlier” in an otherwise strong financial system. However, he acknowledged that the recent turmoil was likely to drag on growth, with the full impact still unclear.
The Fed’s decision to increase rates is a somewhat contentious move given the recent banking failures — the collapse of Silicon Valley Bank, Signature Bank — the US has experienced, and some economists fear that higher interest rates could further weaken the financial sector. However, the US central bank, it appears, says the banking sector is stable enough to handle higher rates.
As Moody’s chief economist Mark Zandi said in a VOX report, “The Fed’s taking a chance with the banking system when they raise rates. It shows a willingness by the Fed to look beyond the crisis and keep its eye on inflation.”
But, what does this mean for the common American man? How does all of this affect his life? We break it all down and simplify the matter at hand.
Federal Reserve and interest rates
The Federal Reserve is the central bank of the United States; it is best known as the orchestrator of the world’s largest economy, determining how much it costs businesses and consumers to borrow money.
The federal funds rate refers to the interest rate that banks charge other institutions for lending excess cash to them from their reserve balances. This means that when the Fed raises rates, as it did on Wednesday, it translates to more expensive borrowing.
Impact on wallets
So, how will the rise in interest rates impact the Americans. Higher interest rates mean the cost to buy a home, borrow to expand a business or take on other debt goes up.
The Federal Reserve doesn’t directly dictate how much interest an individual pays on their card debt. However, the Fed’s rate is the basis for the bank’s prime rate. The latest hike will likely raise the annual percentage rate (APR) on a credit card by 0.25 per cent. This means that the average APR of a 20.4 per cent will increase to 20.64 per cent.
The latest rate increase will cost American credit card users a collective $1.7 billion in added interest charges over the next 12 months, according to a study from WalletHub
When it comes to home loans, there won’t be much change in the mortgage rates. This is because mortgages have fixed rates that are priced with a far longer time frame. However, anyone shopping for a new home has lost considerable purchasing power, partly because of inflation and the Fed’s policy moves.
When it comes to Americans wishing to buy a car, the Fed’s decision will play spoilsport. Though auto loan rates don’t move in step with the Fed’s policy rate, experts say the Fed’s latest move could increase the average APR on a 48-month new car loan by about 12 basis points over the coming months.
As a Bankrate analyst explained, “The increased Fed rate, sitting at 4.75 per cent to five per cent following the March meeting, will indirectly affect your rates. So even as sky-high vehicle prices have fallen 4 percent since its peak this past summer, the increase in interest rates will still result in a more expensive experience overall.”
While borrowing has become more expensive owing to the hike in rates, there’s a silver lining for savers. Savings accounts could see a moderate rise in interest payouts as the benchmark rate rises.
Stocks drop off
The Federal Reserve’s announcement to raise interest rates didn’t fare well at Wall Street. Stocks skidded lower as investors balked at the decision to raise interest rates. The S&P 500 initially jumped after the decision was announced, before falling sharply toward the end of trading, finishing 1.65 per cent lower for the day. The Dow Jones Industrial Average ended 1.6 per cent lower while the tech-heavy Nasdaq Composite Index fell 1.6 per cent.
Don Calcagni, chief investment officer for the wealth manager Mercer Advisors told the New York Times, “This is the Fed making the same policy error that it has routinely made in its history. I think the Fed is slow to react to significant stress in the banking system.”
The global banking turmoil
The Fed’s rise in interest rates come at a very precarious time. The global banking sector has seen some rude shocks in recent days and it all began with California-based Silicon Valley Bank (SVB). On 10 March the bank collapsed — the biggest US banking failure since the 2008 financial crisis — prompting regulators to seize control the same day. So far, the regulators have been unable to find a buyer for SVB and are now considering breaking up the bank, according to Bloomberg.
Also read: 5 banks, 2 weeks: How the banking crisis unfolded
A week on, a second US regional bank — Signature Bank — shut down. Days later, San Francisco-based First Republic Bank sees its stock market valuation plunge and its shares tumble.
And most recently, UBS — Switzerland’s biggest bank — announced it would be buying embattled Credit Suisse for $3.25 billion (Rs .26 lakh crore) in hopes of stopping a wider international banking crisis. The takeover was announced after the 167-year-old lending institution’s shares nosedived to record lows.
With inputs from agencies
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