With the recent collapse of two banks serving as a backdrop, the Federal Reserve hiked interest rates another 25 basis points on Wednesday.
The decision to raise the federal funds rate to a 4.75-5% target range comes on the heels of the collapse of Silicon Valley Bank and Signature Bank earlier this month. Some speculated about whether the central bank would pause its fight against inflation or even cut interest rates in the wake of the banking sector turmoil. Instead, the hawkish Fed pressed on with another interest rate hike – its ninth consecutive increase since March 2022.
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The move to hike the federal funds rate has wide-ranging implications across the economy, especially for retirees and those on fixed incomes. Here’s what you should know about Wednesday’s rate hike.
The Basics of Interest Rate Hikes
The federal funds rate is the target interest rate at which banks borrow and lend money to each other. Set by the Federal Open Market Committee (FOMC), the federal funds rate impacts everything from mortgage rates and auto loans to your credit card’s interest rate.
When interest rates rise, borrowing money becomes more expensive – both for consumers and businesses. This typically causes economic growth to slow. But that’s a worthwhile sacrifice to make in the eyes of the Fed, which is using rate hikes to cool down the economy and curb persistent inflation.
While the central bank previously said inflation was “transitory” and would eventually abate, it’s had to escalate the fight against inflation. In just over a year, the Fed has dramatically raised the federal funds rate target range from 0-0.25% all the way to 4.75-5%.
The Consumer Price Index for All Urban Consumers (CPI-U) – the benchmark by which inflation is measured – rose 6% from March 2022 through February 2023. While inflation has come down since hitting a 40-year high of 9.1% in June, it’s still well above the Federal Reserve’s 2% target, necessitating the Fed’s hawkish stance.
As a result, Federal Reserve Chairman Jerome Powell told the Senate Banking Committee on March 7 that more aggressive rate hikes may be required. But that was before the collapse of Silicon Valley Bank and Signature Bank, leading some to speculate that the Fed could pause or even cut interest rates.
How the Latest Rate Hike Affects Retirees
Here’s a look at some of the implications of Wednesday’s rate hike for retirees and others on fixed incomes:
Cash Becomes More Valuable
When interest rates rise, banks can offer higher annual percentage yields (APYs) on savings accounts and other deposits. While inflation reduces the purchasing power of cash, interest rate hikes mean cash reserves will generate more interest than they would otherwise. This is particularly valuable for retirees who are typically advised to keep between six months’ and two years’ worth of cash on hand to cover their immediate and short-term living expenses. An interest rate hike means that cash will work even harder. In fact, some banks are offering high-yield savings accounts with interest rates north of 4%.
I Bonds and TIPS May Earn Less Interest
Series I savings bonds and Treasury Inflation-Protected Securities (TIPS) are two types of bonds issued by the U.S. government designed to provide protection against inflation. If inflation falls in response to Wednesday’s rate hike – or subsequent hikes – these assets won’t pay out as much.
Twice a year, the Treasury adjusts the amount of interest that I bonds earn, linking those increases or decreases to the CPI-U. The most recent rate adjustment in November saw I bond interest rates go from 9.62% to 6.89%. The next interest rate adjustment will occur May 1.
TIPS work slightly differently. Instead of the interest rate rising and falling with the CPI-U, the principal value of a TIPS bond changes with inflation.
Will Stocks Fall?
It’s unclear exactly how the latest rate hike will affect stocks in the coming days and weeks. As a general rule, though, stocks tend to drop in value when interest rates rise. That played out on Wednesday when the three major indices – the Dow Jones, NASDAQ and S&P 500 – were each down more than 1.60%. As a general rule, higher interest rates slow down economic growth and make it more difficult for businesses to borrow money.
It’s also unclear whether more rate hikes are coming. In a statement Wednesday, the Fed said “some additional policy firming may be appropriate,” but it didn’t explicitly state that rates will continue to rise.
The Federal Reserve raised interest rates another 25 basis points on Wednesday, pushing the target range for the federal funds rate to 4.75-5%. For retirees, that means cash deposits will likely continue to earn more interest. Retirees with Series I savings bonds should keep an eye out for the Treasury’s next interest rate adjustment in May to determine how Wednesday’s rate hike could impact their investments. Meanwhile, stocks fell Wednesday in the wake of the Fed’s announcement.
Tips for Combating Inflation
- A financial advisor can help you manage your investments so they keep pace with inflation. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you’re looking to protect your portfolio from inflation, there are several asset classes to consider. Real or tangible assets like commodities, real estate and infrastructure all tend to outperform other asset classes when inflation rises.
- SmartAsset recently ran the numbers on sample retirement portfolios and found just how much inflation can erode a person’s savings. While a $500,000 portfolio could last a retiree 22 years if inflation remains at 2%, the same portfolio would only last 15 years if inflation was 6%.
Disclosure: SmartAsset has a customer relationship with Silicon Valley Bank.
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