Are You Making the Most of the Federal Reserve Rate Hikes?

How much money do you have in your checking account? How much debt do you have? Why? Here’s why the amount of cash in your checking account matters, and what this amount might imply about you.

The average consumer checking account balance has increased in 23 of the past 30 quarters, according to new research by Moebs Services, an economic-research firm in Lake Bluff, Illinois. Moebs analyzed more than 12,000 depository call reports and compared them with the Federal Reserve monetary data for 2017.

By region, state, city, and asset size, consumers in banks, thrifts, and credit unions keep warehousing more checking dollars. This indicates that consumers don’t feel as secure as they would like about the economy. They don’t feel as safe as some economists would have expected.

The U.S. Federal Reserve (or the Fed for short), however, is on a trajectory to hike interest rates because inflation, a measure of the price changes of essential items, has surpassed the Fed’s two-percent target. The consumer price index (CPI), a measure of the price of food and essential items, climbed to a 12-month rate of 2.4 percent in March 2018 and has more than doubled in the past two years.

When the economy is growing at a fast pace, the Fed raises interest rates — the cost of borrowing money — to prevent the prices of goods and services from rising to unaffordable levels. When the economy is slow, the Fed does the reverse by cutting interest rates to encourage borrowing and investing in an attempt to stimulate growth.

Right now, the Fed perceives a hot economy. But rising inflation and interest rates will have an impact on your checking account and debt.

Before we examine why and to what extent they will do so, let’s understand why the common person’s perception of our country’s economy differs from that of the Fed.

Further Reading: “WTF Is Interest?”

The Implications of the Average Consumer’s Checking Account Balance

In 2018, the average consumer is apparently not at all excited about the economy. Most likely, this is because Americans feel confident enough to keep little in their checking accounts when times are good. On the other hand, when times are difficult consumers stockpile money in checking accounts, effectively pulling back on retail and restaurant spending.

For example, in 2007, just before the Great Recession, times were good and consumers had the least amount of money in their checking accounts — less than $1,000 on average, in fact. Since 2008, consumers have been hoarding more money in their checking accounts.

In beginning of 2018, the average consumer’s checking account had more than $3,700 stashed in it. The median amount in checking accounts since 1991 is $2,263. Anything lower than this amount signifies that the economy is doing well; anything above that indicates the economy is faltering.

Hence, the average U.S. consumer currently feels that the economy is not doing well. This is far from the expectations of any economist, as well the Fed. Indicators such as inflation signal to the Fed that the economy is strengthening and able to sustain an interest-rate hike.

If the average U.S. consumer does not agree with the Fed that the economy is strengthening, then what is the source of rising prices and inflation?

Further Reading: “WTF Is Inflation?”

What Are the Causes of Rising Prices?

The persistent, slow rise in what Americans get paid suggests that higher inflation is unlikely to spring from the tightest labor market in nearly two decades. It’s the stuff people buy that could be the problem.

Even with unemployment dropping below four percent for the first time since Bill Clinton’s presidency, companies are not paying workers much more than they did a few years ago. Despite the low unemployment rate, wage growth remains tepid. The costs of some key consumer staples, however, are not nearly so tame.

Rent, for example, is rising at a 3.6-percent annual rate, and the price of gasoline has jumped 11 percent in the past year. Groceries also cost more now, whereas prices were declining as recently as a year and a half ago.

A measure of wholesale prices, known as the producer price index (PPI), reached a yearly rate of 2.4 percent in March 2018, and it could rise in the coming months. Many companies claim that they are paying more on supplies, most notably steel, following the recently announced White House tariffs.

Further Reading: Get the lowdown on tariffs and trade wars.

These indicators certainly have the Fed on standby. The central bank’s preferred inflation gauge, known as the personal consumption expenditures (PCE) index, has already breached its two-percent target. Other indexes confirm the Fed’s suspicions. Going from two-percent to three-percent inflation, however, is an entirely different story.

The United States has not experienced three-percent inflation, measured by the PCE, in more than a decade.

What may help temper the climb of inflation is consumers’ resistance to higher prices. More and more people shop online, look for deals, or substitute lower-priced goods for higher-priced ones. It’s not easy for companies to raise prices, so they must work hard to control costs, including those for labor, which explains why wages have remained stagnant for a few years now.

As you can see, there is a circular effect. Consumers are not getting paycheck raises, which forces them to shop for better deals, which in turn compels companies not to raise prices, but instead control costs, including labor. The scenario below vividly illustrates this phenomenon:

  1. No wage increase leads to consumer resistance to higher prices.
  2. Consumer resistance to higher prices leads to companies controlling costs.
  3. Companies controlling costs leads to no wage increase.
  4. No wage increase leads back to Point One, and the vicious circle continues.

Wages don’t increase, but interest rates do. It seems that there is a disconnect. Let’s have a look on why we experience the rate increase and how it affects the average consumer.

Further Reading: “Battle of the Best Savings Accounts”

Why Did the Federal Reserve Hike Interest Rates? How Does It Affect the Average Consumer?

There are two main reasons the Federal Reserve raises the interest rate: Either because inflation is running higher than normal, or because the unemployment rate is lower than normal. Considering the discussion above, both reasons are currently in effect.

Therefore, even though your wage is not increasing, the interest you pay is. This is how the Federal Reserve rate hikes might affect you:

Credit Cards

Most credit cards have a variable interest rate with a direct connection to the Fed’s benchmark rate. Expect the two rates to rise in tandem. A 0.25 percent rate hike means that cardholders will pay an extra $2.50 a year in interest for every $1,000 of credit card debt.

Mortgages

Fed rates have an indirect influence on long-term fixed mortgage rates, which are generally pegged to yields on U.S. Treasury notes. Homeowners with adjustable-rate mortgages or adjustable-rate home equity lines of credit, which are pegged to the prime rate, will see a more immediate change. A 0.25 percent rate hike means that borrowers with a $50,000 home-equity line of credit will see a $10 to $11 increase in their next monthly payment.

Further Reading: Learn more about how mortgages work.

Auto Loans

For those planning to purchase a new car in the next few months, a rate increase will probably not have any material effect on the rate you get. Auto loan rates are not directly tied to the Fed’s benchmark rate, although the rate can be an influence. Bigger rate determinants include your credit score and whether you shop around for financing. A 0.25 percent rate hike means that drivers taking out a $25,000 lease will pay an additional $3 per month.

Savings

Banks are always slower to raise rates on saving products than they are on loans and credit cards. Even with a Fed rate hike, banks may not pass any of that increase to the customers. Getting a better yield on deposit may require shifting savings to a competitor, or even better, investing rather than saving. This is especially the case when inflation is rising, yet the interest rate on savings remains close to zero.

Student Loans

Federal student loan rates are fixed. Therefore, most borrowers won’t be affected immediately by the rate hike. If you have a private loan, it may be fixed or have a variable rate tied to the Libor, the prime rate, or Treasury bill rates, which means that as the Fed raises rates, borrowers will most likely pay more in interest, although how much more will vary by the benchmark.

Further Reading: Check out potential student loan refinancing options.

So What Should You Do About the Federal Reserve Rate Hikes?

If you’re hoarding money in your checking account, you’re wasting about 2.4 percent of your money on inflation. Remember, banks are not rolling over the interest hike on savings accounts, and most definitely not on checking accounts. Instead of wasting your hard-earned money on inflation, you should do one of the following (or both):

  1. Pay your debt and decrease interest payments, especially with the rising interest rates as explained above.
  2. Invest wisely. How to invest wisely will be discussed in future articles.

The opinions expressed in this article are those of the author alone and do not necessarily reflect the official policy or views of CentSai Inc.

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