When Will Interest Rates Go Up?

Raising interest rates can help tame inflation

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Rising interest rates increase the cost of credit cards, loans, and mortgages. They also raise the interest you can earn on savings accounts and certificates of deposit (CDs).

On June 15, the Federal Reserve raised rates .75 percentage points, making the target range for the federal funds rate 1.5% to 1.75%. The Board of Governors indicated that they are expecting to continue to raise the rates throughout the year to decrease inflation that has been pushed upward by supply chain disruptions caused by COVID-related lockdowns in China and continued Russian attacks on Ukraine.

This plan won't impact savings accounts, mortgages, CDs, and credit cards all in the same way. Each product relies on a different benchmark. Increases for each depend on how their interest rates are determined. Here's what you need to know about interest rates, when the Fed will raise them, and how your finances will be affected.

Key Takeaways

  • The two most important determinants of consumer interest rates are the fed funds rate for short-term loans and the 10-year Treasury yield for long-term loans.
  • The Federal Open Market Committee (FOMC) began raising interest rates in March 2022, and they expect to continue increasing rates throughout the year.
  • The benchmark fed funds rate has historically had a sweet spot of 2% to 5%.
  • All short-term interest rates follow the fed funds rate. Long-term rates follow the 10-year Treasury yield.

History of the Fed Funds Target Range

The fed funds rate target range was 1.25% to 0.50% as of March 16, 2022. The FOMC had lowered it to 0% to 0.25% on March 15, 2020, to support the economy during the COVID-19 pandemic. The last time it lowered the rate to this level was in December 2008. It stayed there until December 2015.

The 10-year Treasury yield fell to a record low of 0.52% on Aug. 4, 2020. The previous record was 0.54%, set on March 9, 2020. Investors were panicked because of the COVID-19 pandemic. The rate was 2.38% as of April 4, 2022. Demand for ultra-safe Treasuries is likely to remain high during the pandemic.

The Fed also influences Treasury yields. The central bank purchases Treasuries through its quantitative easing (QE) program to keep the yield low.

The FOMC expanded QE purchases to an unlimited amount on March 23, 2020. Its balance sheet grew to more than $7 trillion by the end of May 2020 as a result.

Demand for Treasuries should fall when the economy improves. The yields rise as sellers try to make the bonds more attractive. Higher Treasury yields drive up interest rates on long-term loans, mortgages, and bonds.

How High Can Rates Go?

The Fed didn't plan on raising the fed funds rate until the economy improved and inflation reached an average of 2%. Historically, the benchmark rate has had a sweet spot of 2% to 5%. The highest it's ever been was 19% to 20% in 1980 and 1981.

The Fed raised it to combat an inflation rate of 13.5%. It also raised it to battle stagflation, the unusual circumstance caused by wage-price controls, stop-go monetary policy, and taking the dollar off of the gold standard. The yield on the 10-year Treasury note also hit a record high in 1981. It was 15.84% on September 30, 1981.

Long-term rates could rise at any time because they're bought and sold on the secondary market. But it's unlikely that they'll rise because the Fed is buying enough through QE to keep rates low.

Short-Term Rates

All short-term interest rates follow the fed funds rate. The fed funds rate is the interest rate that banks charge each other for overnight loans. Banks set short-term rates themselves, but they rarely vary from the Fed's target rate.

Banks know that the Fed can use open market operations to pressure them to meet their target rate. Short-term rates affect the interest rates on savings accounts, CDs, credit cards, and adjustable-rate loans.

Savings Accounts and CDs

Interest rates for savings accounts and certificates of deposit track the London Interbank Offered Rate (LIBOR). That's the interest rate at which major international banks are willing to offer eurodollar deposits to one another.

The LIBOR rate rarely diverges from the fed funds rate. Banks may pay you a little less than LIBOR so they can make a profit. Savings accounts may follow the one-month LIBOR rate, while CDs may follow longer-term rates.

LIBOR's status as the relevant price index for consumer products is due to be phased out in stages beginning in 2022, with a full phaseout by June 2023.

Credit Card Rates

Banks base credit card rates on the prime rate, which is what they charge their best customers for short-term loans. It's typically three percentage points higher than the fed funds rate.

According to our own study, the average credit card APR has hovered around 20% from April 2020 through February 2022, depending on your credit score and the type of card. It's always a good idea to pay off any outstanding credit card balances due to the high rates.

Home Equity Lines of Credit and Adjustable-Rate Loans

The fed funds rate guides adjustable-rate loans. These include home equity lines of credit and mortgages. The cost of these loans rises as the fed fund rate rises, so pay them down as much as possible to avoid any surprises.

Talk to your bank about switching to a fixed-rate loan to protect yourself from future rate increases.

Long-Term Rates

Long-term rates follow the 10-year Treasury yield. The U.S. Treasury sells Treasury bills, notes, and bonds at an auction for a fixed interest rate that loosely tracks the fed funds rate. Investors can then sell them on the secondary market.

Many factors influence bond yields, including the demand for the dollar from forex traders. When demand for the dollar rises, so does the demand for Treasuries. Investors will pay more to buy them. Since the interest rate doesn't change, the overall yield falls. 

Demand for Treasuries also increases when there are global economic crises. That's because the U.S. government guarantees repayment. All these factors mean that interest rates on long-term debt aren't as easy to predict as those based on the fed funds rate.

Auto and Short-Term Loans

Fixed interest rates on three- to five-year loans don't follow the prime rate, LIBOR, or the fed funds rate. They're a few percentage points higher than one-, three-, and five-year Treasury bill yields. Yields are the total return that investors receive for holding the bills.

When rates do rise again, you may want to consider keeping your fixed-rate loans. Rising interest rates won't affect them.

Mortgage Rates and Student Loans

Banks set fixed rates on conventional mortgages a little higher than the yields on 30-year Treasury bonds. Interest rates on long-term loans rise along with those yields. The same holds true for student loans. Mortgage interest rates closely follow Treasury note yields.

State, Municipal, and Corporate Bonds

State, municipal, and corporate bonds compete with U.S. Treasuries for investors' dollars. They're riskier than U.S. government bonds, so they must pay higher interest rates than Treasuries.

Fitch, Moody's Investors Service, and Standard & Poor's are the main agencies that rate the risk of default. Bonds with the most risk are called "high-yield" or "junk" bonds, and pay the most return. When Treasury yields rise, so do the yields of these bonds to remain competitive.

Frequently Asked Questions (FAQs)

What happens to bond prices when interest rates rise?

Market interest rates and bond prices will often move in opposite directions. As interest rates rise, bond prices fall. This makes bonds popular investments at times when interest rates are high.

Will house prices fall when interest rates rise?

Interest rates don't directly impact house prices, but rising interest rates can slow demand in the housing market. Fewer people may be interested in buying when interest rates go up because higher interest increases the cost of a mortgage. Housing prices may level off or fall in areas with lower demand.

Article Sources

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  3. Board of Governors of the Federal Reserve System. "Federal Reserve Issues FOMC Statement: March 15, 2020."

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  6. Board of Governors of the Federal Reserve System. "Federal Reserve Issues FOMC Statement, March 23, 2020."

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  9. Bureau of Labor Statistics. "Table 24. Historical Consumer Price Index for All Urban Consumers (CPI-U): U. S. City Average, All Items," Page 4. 

  10. FRED. "Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity."

  11. Federal Reserve Bank of San Francisco. "What Is LIBOR and Why Do LIBOR Interest Rates Move Closely in Line With Short-Term Interest Rates in the U.S.?"

  12. Consumer Financial Protection Bureau. "CFPB Issues Final Rule to Facilitate Transition From LIBOR."

  13. Citizens. "What Is the Prime Rate—and How It Impacts You."

  14. U.S. Department of the Treasury. "Daily Treasury Par Yield Curve Rates."

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