After years of keeping the benchmark federal funds rate at historic lows, the Federal Reserve has been raising it gradually. As you may be aware, rising rates can affect you as a consumer and investor.
The federal funds rate is the interest rate at which banks lend funds to each other overnight to maintain legally required reserves. Although the federal funds rate is an internal rate within the Federal Reserve System, it serves as a benchmark for many short-term rates set by banks and can influence longer-term rates as well. The Federal Reserve and the Federal Open Market Committee (FOMC) operate under a dual mandate to conduct monetary policies that foster maximum employment and price stability. Adjusting the federal funds rate is one way the central bank can influence economic growth and inflation.
In December 2008, the heart of the recession, the FOMC dropped the federal funds rate to a 0.00% to 0.25% range in an effort to stimulate the economy and generate job growth. Recently, the FOMC began to raise the funds rate because it believed that the employment situation was strong enough to begin the transition from emergency measures toward a more “normal” interest rate environment.
As they have indicated that this trend of increasing the federal funds rate is likely to continue, the Central Bank of Trinidad & Tobago has taken notice and has stated that the upward movement in international interest rates have not been matched by a commensurate movement in domestic rates. They go on to state that this narrowing of interest rate differentials could give rise to capital flow reversals.
The prime rate which US commercial banks charge their best customers is typically tied directly to the federal funds rate. Though actual rates can vary widely, small-business loans, adjustable rate mortgages, home equity lines of credit, auto loans, credit cards, and other forms of consumer credit are often linked to the prime rate, so the rates on these types of loans typically increase with the federal funds rate.
Although rising interest rates make it more expensive for consumers and businesses to borrow, retirees and others who seek income could eventually benefit from higher yields on savings accounts and CDs. However, banks have been faster to raise rates charged on loans than to raise rates paid on deposits.
Interest rate changes can have broad effects on investments, but the impact tends to be more pronounced in the short term as markets adjust to the new level. When interest rates rise, the value of existing bonds typically falls. Equities may also be affected by rising rates, though not as directly as bonds. It is however important to maintain a long-term perspective and make sound investment decisions based on your own financial goals, time horizon and risk tolerance.
(Based on an article dated June 21, 2017 by Delray Financial Group LLC – http://delrayfinancialgroup.com/ )