By now, I’m sure you heard that the Federal Reserve Bank (Fed) raised its benchmark federal funds interest rate by 75 basis points last Wednesday. The question becomes, what does this actually mean? What are the implications? How does this change how we operate our businesses?
What the Fed actually did was raise the interest rate it charges your local bank to borrow whatever money the bank needs to handle its lending and other banking requirements. Banks don’t just lend based on their own deposits.
If they want to expand their lending portfolio and increase their income, they’ll do it through borrowing money from the Fed. By increasing that rate, in turn your local bank will also increase the rates they charge you to borrow to maintain their own margins.
The last time the Fed increased this rate by 75 basis points was 28 years ago in 1994. This big move isn’t completely unprecedented, but it just isn’t done.
If you look at a graph of the interest rate over time, the Fed normally raises it slowly in order to not “shock” the overall economy. They’ll increase it a quarter basis point every month until inflation calms down and the economy is back under control.
But that isn’t what they’re doing now. Last month they increased it by half a point and now a full three quarters in basis.
The message is simple. They’re way behind and our economy is out of control.
The Chairman of the Fed has already said he expects another increase of either a half or three quarters of a point next month as well. Most economists are expecting the fed funds rate to increase another 1.5% to 1.75% before the end of the year.
The Fed’s job is to slow the economy and get things back under control, and I applaud their efforts. As painful as this is going to be, it’s a necessity.
Let me leave you with this.
I’ve been warning all of you for some time that we need to change how we operate our businesses. If this much of a rate hike isn’t confirmation, I don’t know what else would convince you.
Lending will become much more expensive. Anything with a variable rate from credit cards to lines of credit will increase substantially.
By definition, it’s foolish to keep $100K in a checking account and maintain $20K in balances on variable rate lending facilities like credit cards or LOC’s. If you’re in this position, pay off these debts today.
One good thing about the Fed’s actions is that the interest rates offered on savings accounts and certificates of deposit will also increase. Once your debts are in order, take a look at your savings.
Next, you should consider your investments. The markets are down substantially. If your retirement horizon isn’t within a short period of time, now would be a great time to invest whatever extra dollars you can.
Will we see enormous amounts of volatility over the next year? Absolutely, without question. But the markets always turn around and equities provide a better return in the long run than debt instruments.
Many should also consider postponing certain financial moves. The costs associated with houses and cars are at an all-time high. In a bad economy, sooner or later, they’ll also come down.
It’s time to be ultra conservative. The things that led to this train wreck of an economy aren’t going to get fixed overnight. You need to stay within your budget.
Your monthly financials are more important than ever. You need them to watch your profits. We all need to live within our means.
Batten down the hatches my Brothers and Sisters. Something tells me that this is going to be a wild ride.
We’re all going to get through this. Let’s get through it together.
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