How Higher Interest Rates “Control” Inflation

Interest rates are going up

Interest rates are going up again and you’ll likely hear this a few more times in 2022, but exactly how many times are we going to hear it? What is it mean for your money and happens in technically control inflation? Comedian keeps reporting that Rising interest rates will keep inflation in check and check inflation in check and you might see that statement and get almost everything across the board is still way more expensive that includes gas, which is seven dollars a gallon Here in the Bay Area.

Ashley, just hit all-time highs of $5 per gallon groceries. Electricity cars used cars in housing costs are all up. Is what the reason why raising rates hasn’t curb inflation yet? Is that typically can take usually one to two years for the effects of raise rates, even play out in real time in order to at least do something as a Federal Reserve, which is the nation’s Central Bank is charged with keeping prices stable.

Federal Funds rate

They have to use their main tool at its disposal and that is to raise the Federal Funds rate, the latest rate hike has the federal funds rate being raised point 75 percent, towards known as 75 basis points which increases the overall rate of between 1.5 and 1.75 percent. At the high-end, this is the single largest increase in the federal funds rate since 1994. So don’t worry, if that all sounds like a bunch of financial journey to you, I’m going to bring it down so that you can easily digest it to. So before I do that, let me rewind a bit and explain what the federal funds rate it is with little bit of a story.

very high inflation

Like, I saw this ugly pair of Yeezys the other day at the store that was priced at $450. I’ll put it on the screen right now. So since a, you want these Easy’s and you ask your buddy, Trevor for a loan of 100 dollars last at you because they’re ugly but he Longs you the $100 anyway, and he wants you to pay him back $105 to make it worth it for it. At the end of the year, that sense he’s created. Kind of like a mini loan to you in the amount of $100 and then extra five dollars.

Borrowing from bank never ends

You need to pay back is Stood by an interest rate, when you are a money, once a you borrow it from the bank will have to pay it back. Usually plus a little bit of extra because they don’t just want to lend you money for free. The federal funds rate is the interest rate that commercial Banks borrow and lend to each other. And it affects almost everything in our financial lives, including the rate at, which they loan you money. If you take out a loan you want the interest rate to be as low as possible, so you don’t have to pay that much money, back on the contrary, if you’re putting money in a savings account, you want the highest interest rate as possible, because that means you’re going to be Money on your savings.

Now, here’s the interesting point, though. Just like you and me where the bank’s customers well commercial Banks like Chase for Wells, Fargo, their customers would be Central Bank. That means that they can deposit their money with the central bank and earn an interest rate on their reserves. So when the federal funds rate is increased, the bank like Chase might be able to earn more from the Central Bank instead of holding it out.

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So if they do loan their money out to the need to raise their interest rate than the charging and that’s for any loan, including mortgages, when interest rates, Rise in directly and indirectly affects the spending Behavior higher interest. Rates means that businesses will find it more expensive to borrow. So there’s less than economic activity through our jobs are created and less money. Overall, the whole point is that hopefully spending and investment slows down so that missis has become reluctant to raise their prices which should reign in inflation. So I’ve covered interest rates in previous videos and in the last one it was thought that by the end of July, we would be seeing an overall interest rate of one-point-seven-five percent and that would be Target for a 2.5 to 3 percent interest rate by the end of the year.

Well, a lot has changed after the last inflation report, the Federal Reserve has decided to get more aggressive and increased it by 75 basis points. 4.75% in addition, Jerome Powell the chair of the FED said that another 50 or 75 basis points. Hike would be likely in July and it is now expected that we’re going to see at least an interest rate of around 3.4 percent by the end of 2020 to Jerome Powell and the Federal Reserve has been facing harsh. And lately for being slow and the stimulus allowing inflation to climb to 40 your highs. Repeatedly saying that they would do whatever it takes to prices.

You also, previously stated that the Baseline for June and July would be 50 basis, point hikes, which is point five percent. But alas, he was wrong, the Fed was wrong in their expectations. The 75 basis points hike, that was announced yesterday, brings a mixed message for investors to digest the height could boost The credibility of the fed by showing their seriousness about inflation, but it could also degrade the feds credibility by showing how bad their expectations and projections have been.

Federal Open Market Committee statements

The past few months. So after their meeting to raise hikes they usually release a statement. This is called the Federal Open Market Committee statement and it can usually tell us a little bit more about the state of the economy as well as guidance for the remainder of the year. I did some deeper digging on the statement and what I found was actually quite interesting first, it noted that economic activity appears to have picked up following, the decline in GDP during the first quarter, and also no longer mentioned the highly uncertain effects of the Ukraine and Russian war.

However, the statement no longer mentioned the strong households You get business investment line and used in the base statement, the FED no longer referencing strong household. Spending makes sense as retail. Sales, numbers have been ugly for the first time in five months, retail sales fell, most notably in big-ticket items such as cars which signals that demand is starting to decline due to inflation when you combine the retail sales, decline with the news from Target, Walmart and other retailers that they have excess inventory.

It’s clear that the US consumer spending is actually slowing down higher. Interest rates can also negatively affect the valuation of stocks and the real State Market. One of the ways investors like to value a company stock is to figure out what that stock earnings might look like in the future, they then work backwards from this projection to figure out what it’s worth today, and that’s actually called the discounted cash flow model when analysts use that model that you typically use what’s called a discount rate to, which is typically affected by interest rates.

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So with Rising rates and actually hurts the value of their future earnings. Since the valuation of growth stocks is heavily reliant on, what’s going to go on in the future or featured earnings growth, the growth Will be more affected than value stocks. As you can see, in this chart as interest rates start to increase this year, the growth sector has actually suffered more dramatically than the value sector. The bottom line indicates vanguard’s growth ETF which is comprised mostly of growth stocks and vtb is vanguard’s value ETF.

Stock market has been struggling this year

This is also why in general the stock market has been struggling this year after so many years of low interest rates higher rates have basically spooked the markets in the real estate sector higher rates will also reduce demand since becomes Some pricier to buy properties. We’re already seeing a massive shake-up in the housing market. Higher interest rates means that mortgage rates will be greater and houses will be more expensive to the new buyers if that affects all new buyers than home prices should come down. And those that own a home, might feel poorer and spend less. Since they are spending less lower spending shooting equal to lower inflation over time. As you can see, in this graph, the 30-year mortgage rate has spiked to levels. Not seen since 2008 and as a results mortgage demand has plummeted to the lowest in

Years in the home builder confidence index has been falling for six consecutive months, interest rates, also affect cryptocurrency. So in terms of cryptocurrency, it’s been a little bit crazy. The serious Bitcoin is down like 50 to 55 percent and aetherium is down. 67% Year date. These days crypto has a correlation to the NASDAQ. So if the tech sector isn’t doing great than crypto has also been following that Trend. Ironically, according to Morgan Stanley, Bitcoin has a negative correlation to gold which I thought was pretty fascinating when interest rates go up. People would rather Just take safe bets like the 10-year treasury. Instead of high-risk high-reward plays like crypto currency.

Essentially, the opportunity cost for investing in speculative assets increases as interest rates, go up. And I mean this kind of makes sense right? Like why would you take a risk on a speculative asset, like aetherium when you can get a decent, guaranteed return. And treasuries, if interest rates are to rise. So hopefully that paints a really good picture of what the interest rate climate looks like right now. So what are some things that you should do right now as interest rates continue to Reese.

So, first off, let’s talk about credit cards, credit card, debt, and other loans with variable, interest rates will get more expensive credit. Card rates are currently averaging 16.6 1%, and it’s estimated to reach 19 percent by the end of the year while fears of inflation and the potential. For a recession can make people reluctant to use of savings to pay down debt. It’ll actually save you money in the long run as interest payments do, add up over time. If you have credit card, debt on multiple cards, I would start with paying off the highest interest rate debt first, if you’re considering taking It’ll only A home or a car in the next few years. It actually might make sense to hold off on these plans and wait to see what happens with interest rates and see if those rates actually come down.

If you’re sitting on cash prices might come down at a faster rate than inflation. So your cash might actually have more leverage there, especially if new buyers can’t afford a home due to the higher rates. Secondly, I would continue to hunt for higher savings rates. Currently, the average savings accounts rates at banks are a measly point zero seven percent but there are online savings accounts that average one percent since they have lower. Overhead costs compared to a Traditional Bank.

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Also high yield savings accounts will usually offer higher rates as the interest rates, take upwards, so if interest rates keep going up than the higher yield interest savings accounts should also increase their rates as well. Another thing that you can look into buying is the series. I savings bonds from the US government. The interest rate for those series. I savings bonds is now a nine point six two percent and it’s virtually a risk-free return that you get because it’s backed by the United States. You can go to treasury direct dot-gov and the rain is good through October 20, 22. 

New rates are set depending on inflation metrics, there is a limit of ten thousand dollars per calendar year on the savings bond. But the cool thing is that you can actually buy it for others as well. Like your children, right? So let’s say, if you do buy a savings bond, there are two key dates, you need to keep track of, and that’s going to be in year, one and year 5 after your one, that’s when you can cash out the bond for the interest, but you will pay a three month interest penalty for being so early. After year, five, that penalty goes away, because you’re holding it for a long period of time. So basically, the government is trying, And to incentivize you to save through the savings bond to fight against inflation, but it wants you to do it over a long period of time, that actually provides a decent return in the medium term and it’s actually a pretty good option.

For many people out there that just have excess savings sitting around their bank accounts. If you are interested, I’ll link the relevant resources for you guys in the description below. It’s just the treasury direct website. Now on two different investment opportunities, by the way this is not Financial advice but purely, what I am personally doing. I personally would avoid Investments such as the tips or treasury inflation-protected securities.

And gold as well as the Wall Street Journal describes it. Adding inflation protection to your portfolio. Now is like buying homeowners insurance. While your roof is on fire, the return you get with investing with tips is based on the unexpected changes in inflation expectations because the FED is actively working to bring down inflation. The likelihood of inflation expectations continuously changing doesn’t seem that likely, on the other hand, gold hasn’t been a grade inflation hedge because they typically rise in anticipation of inflation rather than with inflation itself.

It seems like Every video on finance and investing comes down to this, but the best idea here is to diversify your Investments across all different asset types. If your time Horizon is for the long term, there’s not much to worry about because of perspective in 10 to 20 years looking back. How will all the prices look today? There’s no doubt that there’s plenty of uncertainty, but I think that over time, writing out volatility and doubling down on dollar cost, averaging into index. Funds will always be a decent choice and it’s personally what I’m doing, especially if your time Horizon is long like on Rising interest rates can be painful.

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