3 - 5 minute read
In a surprise move, the Federal Reserve has raised the interest rates again by 0.25 percent. Just over a year ago, the Fed funds interest rate was practically zero at 0.25 percent. However, after today’s announcement, the Fed funds interest rate has increased from 5.0 to 5.25 percent. It remains to be seen if this is the last increase in this economic cycle. In this article, we will review why the Federal Reserve made this decision, the economic consequences, and what traders can expect in the months ahead.
Real Estate and Housing
One sector that is more interest rate sensitive and already feeling the impact of the higher rates is real estate. As we recently covered in a video, the volume of homes being bought and sold has plummeted, and real estate activity has fallen off a cliff. This is because of higher mortgage interest rates. If you own a home with a three percent mortgage interest rate, you are unlikely to sell your home in this situation. This is because trading your three percent mortgage interest rate for a six percent rate just doesn’t make sense. Consequently, there are fewer sellers, and as a buyer, higher interest rates make your monthly payments ridiculously expensive. Therefore, there are also fewer buyers, making it a lose-lose situation for the real estate industry.
Tech Industry
The tech industry is another sector that is feeling the impact of the higher interest rates. Smaller tech companies typically burn money. Although most of these companies had net losses, they promised to make money in the future. However, with higher interest rates, their promise of future cash flows is less attractive. That is why tech companies’ stock prices and valuations have been coming down and have come off greatly from their peaks. If your friend asks you for money, you would be more open to the idea of lending your friends some money if inflation is close to zero and interest rates are at zero percent. However, with interest rates so high, you may not want to loan out your money for free when you can just stick it into a savings account or CD and earn five percent interest.
Manufacturing
Manufacturing makes up 11 percent of the US economy. Production at US factories fell more than expected in March, with the Federal Reserve reporting that manufacturing output dropped by 0.5 percent last month. The sector is struggling because higher interest rates reduce demand for goods that are typically bought on credit. Less demand means that businesses are left holding excess inventory, and they place fewer orders with the factories. The ISM Manufacturing data shows five straight months of manufacturing contraction.
Banking
Banks are tightening up the flow of credit, which continues to slow down, causing more drag on the economy, from home loans to auto loans to business loans. This tightening of credit will cause further damage to the economy.
The Bottom Line
Higher interest rates have already caused damage to interest rate sensitive sectors such as real estate, tech, manufacturing, and banking. This damage ripples into the general economy, but it takes time for the broader economy to feel the pain because there is a lag effect. You will see unemployment go up, and GDP will come down. The Federal Reserve is expecting unemployment to increase from 3.5 percent to 4.5 percent by the end of the year, which means over 1 million Americans will lose their jobs in the next eight months. Additionally, the Fed expects that the US economy will be in a recession by the end of the year. Traders should be aware of the potential opportunities or risks that these changes could bring to the market.
