Friday 21-Apr-23

“The Fed is Hiking Rates”. What does it mean in simple terms?

The US Federal Reserve has been raising interest rates since March 2022, to bring down inflation. High inflation, which means prices are rising, is not good for the general public, and every country tries to control it. The Federal Reserve plays a key role in controlling inflation in the US, and since the US is the world’s largest economy, this affects the whole world.

The main way it does so is by raising and lowering interest rates. Higher interest rates mean that it will be difficult to borrow and buy. For example, if your home loan interest rate rises, you will be reluctant to borrow and buy a house. This will lower demand for houses and bring down prices. On the other hand, if you can borrow at a very low rate, you will be encouraged to buy, which will increase demand and prices.

Technically, the Fed aims to adjust the federal funds rate, which is the interest that banks charge each other for very short-term risk-free loans. This rate serves as the basis for interest rates on other loans. So, let’s say, a bank borrows 100 dollars at the fed funds rate of 3% and lends it to a homebuyer at 5%. If the Fed hikes the rate to 5%, the bank will also raise the interest rate on the home loan to protect its margin.

Currently, the Fed funds rate is around 5.5%. Did you know that it was almost 0% until March 2022?

Market expects the rate to come down next year, as inflation is declining. I guess most of us will like lower interest rates. Do you agree? Let us know in the comments.