How an interest rate hike ripples through the economy
Well, it’s finally here, the day the Federal Reserve raised interest rates for the first time since 2006. No more wondering about when the Fed will move; the Fed has moved. The central bank said today that it’s raising the target for its federal funds rate a quarter percent.
Many areas of the global economy is affected by this rate, either directly or indirectly, said Carl Tannenbaum, the chief economist at Northern Trust. The federal funds rate “affects virtually all equity markets around the world, all currency markets, it affects interest-rate markets and it could trigger other policy actions elsewhere in the world.”
In fact, the ink was barely dry on the press release before the big banks reacted. Wells Fargo, US BankCorp and JP Morgan Chase all bumped up their prime rates a quarter percentage point.
But the Fed doesn’t have some magic button that will raise all rates the same quarter-percent all at once. It might take hours, days, maybe even weeks for the implications of the Fed’s move to sink in and impact other rates.
Take the interest rates paid on a savings account, for example.
“The interest rates on savings should go up, of course, [but] the amount and the timing with which those go up are matter of supply and demand,” Tannenbaum said.
And what about mortgages? “Both up, adjustable-rate and fixed-rate mortgages,” said Vincent Reinhart, a visiting fellow at the American Enterprise Institute. “The adjustable-rate goes up more at first.”
Or, at least, that’s what we’d typically expect when the Fed raises rates. But markets don’t always behave in the way we might predict.
“I have home buyers now that are looking to close their transactions in January and I’ve actually been advising them to hold off,” said Rocke Andrews, a mortgage-loan originator in Arizona and the president of the National Association of Mortgage Brokers. He says adjustable-rate mortgages might go up now that the Fed has raised its federal funds rate, but he thinks longer-term mortgages may actually go down a little.
“Keep in mind that I’ve been wrong before,” he joked. “That’s what I tell my borrowers.”
Historical precedent isn’t any much help in predicting market reactions and how the Fed’s decision will ripple out.
“It’s just hard to judge these things because history does not provide clean examples,” said Robert Shiller, an economics professor at Yale. “This is a major turning point, if after so many years of zero interest rates, it’s actually going to be something that matters. That’s a big turning point and we don’t have history to guide us on what to expect.”
Normally, increasing rates a tiny quarter-of-a-percent? Yawn. Sigh. Snooze. Plus, this move was very well telegraphed. However, since this is the first increase after many years, it may carry a bit more weight.
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