In the last 2 years, we faced an unexpected pandemic that temporarily caused us to shut down our economy, we've seen dramatic increases in inflation, and now we are witnessing Russia's assault on Ukraine and democracy as a whole.

With all of these unprecedented events, we have gotten to witness monetary policy in action.

Monetary policy is a set of tools that involve manipulating the nation's money supply in order to affect the economy. Sometimes, when the nation's economy is struggling, we need expansionary monetary policy which promotes economic growth by increasing the nation's money supply. Other times, when the economy is growing too quickly or when inflation is high, we need contractionary monetary policy which contracts the economy by decreasing the nation's money supply.

When the pandemic hit in February 2020 and the economy grinded to a halt, the Federal Reserve attempted to re-ignite the economy by implementing expansionary monetary policy. One of their primary methods was to decrease interest rates which brings down the cost of borrowing money and promotes large purchases in the economy. This expansionary monetary policy, in part, helped our economy get going again.

One might argue that it worked too well because by late 2021 we started to see that inflation was rising quickly, indicating an economy with too much money in the system. With inflation readings at higher levels than we have seen in years, 2022 is expected to be a year where the Federal Reserve returns to contractionary monetary policy.

One of the main methods the Federal Reserve will likely employ involves raising the nation's interest rates which brings up the cost of borrowing money and slows enthusiasm for large purchases in the economy. 

Cetera Investment Services updates its "Fed-O-Meter" on a monthly basis which shows where they see the Federal Reserve heading on monetary policy. 

So, with interest rates expected to increase throughout 2022, how does this impact you?

Impact #1: Your Personal Debt

If you have any personal debt including a mortgage or a car loan, check to see if you have a fixed or a variable loan. If you have a fixed loan, your interest rate is set and an increase in rates will not impact you. If you have a variable loan, however, your interest rate may increase in the near future. This might cause your monthly payment to increase and will increase the total amount you will pay toward your debt.

In addition, your credit card interest rates could increase. This is because annual percentage rates (APR) on credit cards hinge closely on the rates and targets set by the Fed. Experts suggest that with rising interest rates looming, it is wise to pay off as much of your credit card debt as possible so you don't end up getting charged higher interest.

Impact #2: Your Investments

Rising interest rates can impact the stock and bond markets in different ways. Logic follows that if interest rates rise and the cost of borrowing goes up for corporations then there could be a negative effect on corporate profits and their stock prices. However, because of the low interest rates in previous years, stock prices have risen steeply and stocks are considered "expensive" with high Price to Earnings (P/E) ratios. A correction could bring prices back down to affordable levels for investors. Also, the equity market tends to be "forward looking" and may price in expected interest rate increases several months in advance.

In addition, rising interest rates typically causes the price of existing bonds to fall, since newer bonds are being issued with higher and more attractive interest rates. One way to mitigate the risk of rising rates is to invest in bonds with shorter maturities, which have less sensitivity to rising interest rates. Bonds still remain a great asset class that provides stability and diversification for a fully diversified portfolio.

Impact #3: Your Financial Goals

Many of the most common goals like buying a car or buying a home involve making large purchases. In order to afford these things, most people need to finance these purchases or take on a loan. Your loan details including your monthly payment depends heavily on your interest rate. Your loan interest rate typically takes your individual credit history into account as well as the national interest rate environment. If interest rates across the country increase, then interest rates for car loans and mortgages typically increase as well. This means that the purchaser will have to pay more on monthly basis and more in total for the same large purchase.

With that in mind, if interest rates are expected to increase in the near future, now may be the time to take out that car loan or mortgage and lock in a lower interest rate. If you wait, you could end up paying significantly more to accomplish the same goal.

Overall, rising interest rates typically indicate a challenging path moving forward. However, if the contractionary monetary policy works as expected, we should see inflation start to calm down and our economy start to settle. Historically, these things are cyclical, so rates won't be increasing forever.

To chat more about interest rates and how they might affect your debt, your investments, and your goals, schedule a meeting with one of our planners:

To schedule with Alex, Click Here.

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Best,

Alex