Effect of the Federal Reserve raising interest rates on consumer

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The Federal Reserve is in charge of the economy's affairs in the United States. It carries out critical operations to maintain and control economic surveillance. The effect of rising interest rates has been felt more acutely in automobiles and housing. The rise in interest rates impacts customers, who rely heavily on loans to fund their access to these goods. As a result, the decision to raise interest rates has a major impact on borrowers in the above industries (Bonis et al., 2017). Since the elevated unemployment rates in the United States in 2008, one of the measures implemented by the Federal Reserve was to reduce interest rates. This was majorly taken to safeguard the economy economy and maintain the lifestyle of its citizens. After the economic crisis, the mortgagee was bottoming at 3.5% interest rate (Ihrig et al., 2016).

This was affordable to the investors as well as other consumers who wished to own houses. However, if the interest rates rise, the banks pass on the expenses to the final consumer. The mortgage rates have been shooting in the recent months. Fed has speculated an anticipated increase in the rates of interest. The current rate of accessing a mortgage is 4.3% (Bonis et al., 2017). This is an increased figure compared to what the US citizens have been used to. The changes are witnessed at times when the nation is struggling to mitigate the challenges which are posed by high inflation rates. For example, taking a 30 year long term loan is worth $237,000. Complete repayment of the loan would cost an extra $50,000(Ihrig et al., 2016). There is a high likelihood that people will not like to own houses and those who already have would not refinance.

Car loans are also rising as indicated by Federal Reserve. Just like the housing loans, accessing funds from the bank to buy a vehicle in the current economy is higher than the previous year. The trend would discourage people from owning vehicles and seek alternative means of transport. For example, there would be increased use of public transports. Another scenario is that the public means would experience increased price to supplement the cost (Bonis et al., 2017). Notably, any cost that an investor incurs is directed to the consumer. In two years’ time, accessing car loans will be tricky. Federal Reserves estimates that the current situation will not revert in the near future. The dwindling economy and increase in inflations rates will continue to go high (Kozul, 2016). They suggest that accessing cars immediately would save the individual from higher charges which are anticipated to increase in future.

Effect on Annuities

Annuity is financial product which is offered by the financial institutions with the aims of growing the income of individuals. It is a form of insurance and therefore very pertinent to people of United States. The accumulation period matters a lot for the person who has indulged in the business of buying annuities (Williamson, 2017). This is the period which is affected by varying interest rates and hence has a significant meaning to the buyer. Interest rates in the United States have been kept low since the financial crisis which occurred in the year 2008. The central bank has ensured the rates are kept low, to reduce the cost of borrowing. Last year the annuity rate fell by 24 %( Kozul, 2016). This resulted to people fearing to invest in these form of trading. However, the projected increase in interest rates would mean that the value of annuities will increase in future.

Policy makers in the United State states that the interest rates would increase in June, which translates to high values of annuities. From the argument posed by the economist, the opportune moment that an investor can grab is the current time. Well, the trends have shown a progressive increase in interest rates in the past years. The scenario is not expected to revert in the near future (Bonis et al., 2017). Buying of annuities at this period would accumulate more interest to the benefit of the buyer. If the interest rates increases as it is projected, those who have invested in annuities in the present time will have more benefits. Waiting to buy them in the future might increase the cost of buying and hence not enjoy much benefits. Two factors that affects the income received from annuities are interest rates and the length of the annuity. Long term annuities would increase income with continued rise in interest rate.

Effect on NPV Calculations

Net present value is the basis of investment judgment. Calculations which are made regarding the NPV are indicators of what the institution should expect as return. It is defined as the difference between the current inflows and income outflows (Kozul, 2016). This figure is affected by the interest rates prevailing in the economy. It is a tell sign of what kind of investment one should engage in to prevent making huge loses. Federal Reserve interest rate increase projection could affect the NPV calculations negatively. The current NPV value in the united State stands at 1.22(Bonis et al., 2017). This figure is unit less but has a lot of meaning to any investor. This figure is calculated taking into considerations of the flow of income in the economy. From the calculation, the expected rate could down to 1.0 in the coming future due to increased rates (Ihrig et al., 2016).

The effects of high interest rates affects every individual in the economy. Both the consumers and producers stands the chance to feel the pinch of high interest rates. This affects the consumption hence production is reduced. If we consider these transactions in terms of income, the investors will lower the borrowing rates (Bonis et al., 2017). This means little investment of expansion of the business will occur. The resultant is reduced employment and decrease in supply of goods and services. The inflow of income will reduce and outflow probably increase. There will be more spending than income inflow into the economy. This is not healthy to any nation. NPV values is a reflection of the economic performance. This value is paramount in making decisions and it’s essential to understand various figures that are associated with its calculations (Kozul, 2016). For example, Federal services is estimating an increase in interest rates. Relevant bodies should take control and try to balance the inflows and outflow to avoid possible economic regression.

Effect on Weighted Average Cost of Capital

There are some factors which are within the control of an organization when calculating WACC while others are beyond their measure. Interest rates keeps on changing depending with the market environment (Williamson, 2017). This is a strategy by the government to balance the economy. The alteration occurs as a results of unemployment, changes in inflations rates and other elements which affects the economic performance. WACC is defined as the average payment which is done to security holders. This payment is dependent on the rates of interest which is charged by the banks. The current Federal Service interest rates is at 0.25% with an estimated future increase by another quarter (Kozul, 2016).

Increase interest rates is favorable to the banks and other lenders since they reap more from the shareholders. Increase in interest rates is directly proportional to the payment made to the shareholders. However, a decrease has also linear relationship. A lower interest rates would call for a lower WACC. The increase which is anticipated would see more money paid to the shareholders.

Effect on Corporate Earning

These is referred to as profit which is realized by an organization after a certain trading period. The earning of any business is affected by the interest rates in the country. Such business are reliant on lenders to finance some of the projects which require huge capital. The changes in interest rates impacts the running of any business. Currently, the average corporate earnings in the United State is 1630.20USD billion (Boni et al., 2017). This is as a result of reduction of inflation to 2.4%.The increase in interest rates would impede investment growth. As it was alluded in the previous paragraph, any change on upper scale would result to discouraging institution from increasing their services. The market would witness reduced employment and even quality of goods will lower. Additionally, employee turnover would be witnessed as a result of low payment and sometime delays of release of salaries (Kozul, 2016). The overall loser is the organization in general. Income received is expected to lower due to reduced sales. Essentially, the problems spills over to the final consumer, who will suffer the challenges of accessing goods and services.

References

Bonis, B., Ihrig, J., & Wei, M. (2017). The Effect of the Federal Reserve's Securities Holdings on Longer-term Interest Rates. FEDS Notes, 2017(1977).

Ihrig, J., Meade, E., Weinbach, G., & Josselyn, M. (2016). The Federal Reserve's New Approach to Raising Interest Rates. FEDS Notes, 2016(1706).

Kozul, N. (2016). Effects of raising US interest rates on global FX markets. Bankarstvo, 45(1), 42-53.

Williamson, S. (2017). Low Real Interest Rates and the Zero Lower Bound. Federal Reserve Bank of St. Louis, Working Papers, 2017(010).

November 09, 2022
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