The Effect the Federal Funds Rate has on Your Life

On Wednesday afternoon, Jerome Powell (Chairman of the Federal Reserve) announced a .25% federal funds rate hike bringing rates from 4.75% to 5%, the highest level since 2007.

What is the Federal Funds Rate?

The Federal funds rate is the rate that banks are required to use to borrow and lend against. This rate is set by the Federal Open Market Committee (FOMC) who meet 8 times a year to decide on a target for the federal funds rate.

Why is this important?

The federal funds rate has a strong influence on other rates used by consumers more often. Things like, mortgage rates, consumer loans, car loans, and credit card interest rates. As the federal funds rate rises, things like homes (through mortgages), cars (through car loans), and small business (through business loans) become more expensive to purchase.

Businesses also feel the pinch from the federal funds rate. As the rate increases, so does the cost of the loan that a business would need to start new projects, hire new people, and grow their company. A lot of businesses use adjustable-rate loans which move with the federal funds rate every few years. This can become problematic for a business who started a project on low interest rates that gets readjusted into a higher rate making the project less (or not) profitable.

Americans 2 Paths.

In my previous newsletter I wrote about the two paths America would have moving forward America's Only Two Financial Paths Moving Forward | The Hill Meets Households (beehiiv.com). With Powell coming out and announcing they will be raising rates; it looks like the Fed has chosen its path (for now).

Raising Rates are tied to a recession.

As mentioned above, raising rates make things more expensive. When things become more expensive less people buy those/products or services. When less people buy those products or services, the company selling those products/services have less money to pay their employees. This results in layoffs which causes less people to have money to buy more products and services. Eventually, this could lead to a recession.

These rising rate periods can also be prolonged by government spending. The more the government prints money, the longer rates have to stay elevated to keep money “expensive”. This is what some speculate Powell is referencing in the recap tweet above.

Ways to prepare.

There are lots of different strategies to prepare but here are a few that I think are important. (Please note that I am not a financial advisor, and you should only take this as my opinion and not something I am advising you on. Reach out to a professional for specific questions and advise).

• Save a few months’ worth of expenses in cash in case of a job lay off or an unexpected event.

• Keep a few days/weeks’ worth of food and water. It might seem silly but it’s better to have it and not need it; then to not have it and need it.

• Have a plan in place for different types of situations (layoffs, high interest rates, even the purchasing of assets).

• Keep luxury spending to a minimum for 2 reasons, 1) it’s nice to have extra cash for emergencies 2) recessions are the best time to buy assets (stocks, homes, valuables - things that can make you money). You have years to go out to eat and buy different color throw pillows but there’s only a limited time to buy discounted assets.

This newsletter is not meant to panic anyone, rather it is meant to provide families and households with the information needed to make accurate plans and informed decisions. In the world today there is an abundance of useless information coming from 1,000 different outlets. Our hope is to bring clarity to the information that is relevant and often suppressed, even if it may not be what you want to hear.

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