Recent Fed Rate Hike Good for Savers, not Borrowers

Earlier this month, in an attempt to get a grip on inflation, the Federal Reserve Board, America’s central bank, raised interest rates a quarter of a percent for the first time in three years. KSFR reporter Mary Lou Cooper reached out to University of New Mexico economist Professor Reilly White to find out the implications for consumers here in New Mexico and across the nation. Professor White is the chair of the Finance Department at UNM’s School of Business Leadership. Below are the highlights of their interview.
What are the Fed’s benchmark interest rates and how do they relate to mortgage rates and other costs of borrowing?
The Federal Reserve controls just one important short-term interest rate, the overnight lending rate for large banks that is at the heart of the banking system. The Fed rate has ripple effects on the rest of the economy. It does not per se set your mortgage rate, your car loan rate or your credit card rate, but its decisions influence the financial markets that do. Think of interest rates as the price of borrowing money. Credit card interest rates and other variable rates feel the impact of a Fed rate hike pretty quickly. A 30-year fixed mortgage is more closely connected to bond markets and expectations about inflation and the broader economy. When the Fed is worried about inflation, it raises interest rates.
How will such a relatively small hike curb inflation? Will the increase really help lower gas prices or reduce costs related to tariffs or the high cost of living?
A quarter of a point sounds really tiny to most folks. But the Fed is trying to change millions of little decisions that are being made at the margins. A business could look at a new investment and say maybe we’ll wait because taking out a loan for this is too expensive. A family looks at financing a car, and they might say maybe we’ll keep this old one for another year. And a developer might look at a project and say the numbers don’t really work anymore. If you multiply this across an economy with 340 million people, that does affect demand. The Fed can make borrowing and investment more expensive, but it can’t produce a barrel of oil. It can’t build an apartment to alleviate our housing costs. And it can’t remove a tariff. The Fed has the brake pedal for demand, but it doesn’t perform any of these critical activities that make stuff happen. Raising rates won’t reduce the tariffs, but it can reduce demand elsewhere in the economy and prevent even broader inflation. That’s what the Fed is trying to control at the end of the day.
What will the effect be on New Mexicans who want to buy a new home or car or pay off a credit card debt? What’s your advice to consumers?
If you already have a fixed-rate mortgage, nothing about Fed rate hike will affect it. But if you’re carrying variable rate debt like credit card debt, you’re more exposed. Here in New Mexico, the average credit card debt is about $6000 which is a lot of money. If you’re someone buying a house or car, there’s a temptation to be an amateur Fed forecaster. The best solution is to shop lenders and compare the cost of borrowing. Make sure your payment works at today’s rate. Rates may fall, and refinancing could make sense, but nobody is sure when that might happen. Buy the house or car you can afford at the actual rate you have today, not the rate you hope to have in the future.
New Mexico’s unemployment rate is 4.7 percent, compared to 4.1 percent nationally. Will the Fed’s interest rate hike affect unemployment or are these two things unrelated?
The Fed has two jobs—maximizing employment as well as keeping inflation at around 2%. In a way these goals are connected. Higher rates are designed to cool spending and investment and help bring inflation down. But when businesses see less demand, they tend to hire less aggressively. The Fed is trying to cool inflation without cooling the labor market too much. But the same sort of national “medicine” can have different economic effects from state to state. The Fed rate hike won’t change the hiring process across all the states tomorrow, but it does mean businesses are going to be more cautious around hiring. Historically, the Fed doesn’t raise rates just once. This will probably be just the first of several rate hikes in the coming months to year. That will put more stress on the job market nationally and in New Mexico.
Will Fed rate hikes do more harm than good? Who might benefit?
Monetary policy always involves a trade-off. Higher interest rates impose real costs on borrowers today. But the consequence of not raising rates is the possibility of higher inflation down the line. Elevated prices impose real costs especially on households. On the benefit side of the equation are savers. Higher interest rates mean higher yields on savings accounts, Certificates of Deposit (CDs) and other money market products. At the end of the day, the Fed’s job is not to make borrowing cheap or expensive. Their job is to keep prices stable and maintain maximum employment. The real difficulty is that these two objectives don’t always cooperate.
KSFR also reached out to the Santa Fe Association of REALTORS for a comment on the Fed rate hike. Here is an excerpt from their reply. "While the Federal Reserve raised its key benchmark rate by a quarter percentage point recently, its first rate hike in three years, it doesn’t mean mortgage rates move in lockstep with the Fed. Mortgage rates are influenced more directly by broader financial markets and long-term bond yields.  However, the 10-year Treasury yield, a key indicator for mortgage rates, recently climbed to its highest level in nearly two decades, adding pressure to borrowing costs.  Higher rates can translate into a larger monthly payment and less purchasing power for buyers."