[Tommy-G]

I never had any real understanding of investing, I made money and I spent some and I saved some…..

Give me a crash course for dummies on what’s going on and how it affects inflation

[RickFLM4]

Broadly speaking, higher rates discourage consumption (thus decreasing demand to cool off prices). But it’s more complicated than just that, especially this time around because inflation is high in large part because there isn’t enough supply for many products. Rising interest rates also discourage businesses from borrowing to invest in capacity so supply may remain constrained for some time. We’ll see how it plays out, but I expect lower income people to get crushed as rates rise and prices don’t necessarily drop quickly.

https://www.cnbc.com/2022/06/15/fede...inflation.html

[2000cs]

For investing, the value of future earnings and dividends is discounted by the appropriate interest rate (shorthand, but essentially correct) for the term. So higher rates mean lower present value of future performance, as well as lower earnings because of higher borrowing costs, etc. Double whammy for tech, for example. Also means dividend stocks, like utilities, will likely fall in price to bring the dividend yield in line with interest rates.

Markets anticipate, so Monday the sell-off was largely attributable to the Fed signaling today’s 75bps increase (was 50bps most likely before Friday’s CPI).

Short term there is a lot of volatility because there is high uncertainty about the near-term course of inflation and growth/recession. As that clarifies, the market will stabilize and move in the appropriate direction longer term.

[BRAKE!]

Hey Tommy,

So your question revolves around how the Federal Reserve raising its interest rate (AKA federal funds rate) affects inflation.

Well, Federal Reserve exists as a quasi gov’t entity that monitors the overall status of the economy and the money circulating in it. One of the jobs it does is to monitor inflation/deflation by the way of an index called Consumer Price Index (CPI) among other indices. CPI measures what a basket of goods/services would cost an average American family currently vs what it cost a year ago - essentially food, clothing, shelter, energy, transportation. It is measured monthly.

The Fed then uses the rise and fall of this data to determine what the purchasing price of the dollar has become; inflation, if costs rise above expected norms (meaning the dollar doesn’t go as far as it once did) and deflation if vice versa. Currently, based on the CPI, cost is now up 8.6% from year ago. (FYI the target inflation rate from year to year is ~2%… we are 4x that now)

So, in our current situation consisting of - 1) costs of goods sky rocketing due to demand, 2) shortage of supply, 3) BUT ALSO the ABILITY to PAY for these ever rising costs due to government COVID stimulus money pumped into the economy - is what resulted in high inflation. High inflation is bad for the consumer as the cost of living goes way up and those at the bottom of the socioeconomic ladder will suffer on a daily basis because of it (leading to upheavals, etc. e.g. post WWI Germany).

The Fed has a few tools to be able to control this inflation. One of the ways they do it is by raising the Federal Funds Rate (AKA, base rate, floor rate, interest rate of the banks, etc). This is essentially the interest rate that the commercial banks (e.g. Bank of America, Wells Fargo, etc) uses to borrow money from each other and from the Federal Reserve. When the Fed Funds Rate goes up, then it costs the banks more money to borrow from each other and therefore, they pass on this higher cost to the bank’s customers as a way of higher interest rates. This theoretically will decrease borrowing from individuals buying homes/cars/etc, and decrease businesses from expanding, because money is now more expensive to borrow. The overall effect on the economy is that the circulating money decreases, demand decreases and thus, inflation decreases as well (less people trying to buy goods, demand falls, prices fall with it).

Now, if this is overdone and the Fed Reserve raises interest rates too much to a point where demand precipitously drops off, then the economy will slow to a point of recession (where you fall into a vicious cycle of - no one’s buying anything, businesses stop producing as much products and lay people off, then people without jobs have no money to buy anything… and so on and so forth).

I’ll stop rambling now, I hope that answers your question.

[ryan stewart]

Originally Posted by RickFLM4

Broadly speaking, higher rates discourage consumption (thus decreasing demand to cool off prices). But it’s more complicated than just that, especially this time around because inflation is high in large part because there isn’t enough supply for many products. Rising interest rates also discourage businesses from borrowing to invest in capacity so supply may remain constrained for some time. We’ll see how it plays out, but I expect lower income people to get crushed as rates rise and prices don’t necessarily drop quickly.

https://www.cnbc.com/2022/06/15/fede...inflation.html

Concur. It's gonna impact debt loads and saving but it's not really gonna have the price impact it usually would because the issues we face now are novel.

We're still figuring out both COVID AND the boomers aging out all at once.

[infinitekidM2C]

Originally Posted by RickFLM4

Broadly speaking, higher rates discourage consumption (thus decreasing demand to cool off prices). But it’s more complicated than just that, especially this time around because inflation is high in large part because there isn’t enough supply for many products. Rising interest rates also discourage businesses from borrowing to invest in capacity so supply may remain constrained for some time. We’ll see how it plays out, but I expect lower income people to get crushed as rates rise and prices don’t necessarily drop quickly.

https://www.cnbc.com/2022/06/15/fede...inflation.html

I agree. Not sure this is going to lower prices on household goods/needs because the supply just aint there. Not sure the demand is anything crazy either.

[ASAP]

It is absolutely the right move and needs to keep going... its just sadly 6 years late.

If you want to learn about real movements in the 80s, read about Paul Volcker.

[KevinC]

Ah, memories of double-digit mortgage rates and 18% car loans (with perfect credit), coming out of the Jimmy Carter debacle. Hold onto your jockstraps boys, this ride is about to get VERY rough.

[ASAP]

Originally Posted by KevinC

Ah, memories of double-digit mortgage rates and 18% car loans (with perfect credit), coming out of the Jimmy Carter debacle. Hold onto your jockstraps boys, this ride is about to get VERY rough.

You have to really wonder why the rates were reduced in 2018 and we literally had the fed chairman threatened to keep rates low for political reasons... in the middle of the fking hottest economy ever.

Now everyone panics over a 75 bps hike... the market, politicians and most people are completely out of touch with reality.

[RickFLM4]

Originally Posted by ASAP

You have to really wonder why the rates were reduced in 2018 and we literally had the fed chairman threatened to keep rates low for political reasons... in the middle of the fking hottest economy ever.

Now everyone panics over a 75 bps hike... the market, politicians and most people are completely out of touch with reality.

They raised rates very slowly in 2017-2018 and cut them in 2019 and of course 2020 when COVID hit.

[ASAP]

Originally Posted by RickFLM4

They raised rates very slowly in 2017-2018 and cut them in 2019 and of course 2020 when COVID hit.

Yea and why is the real question... insanity... they saw a tiny reaction by the market and panicked.

[M_Six]

Is there any chance these higher rates will translate into better CD and bank interest rates? I remember 9% CDs. Those days are long gone, it seems.

[Nuckle]

Originally Posted by M_Six

Is there any chance these higher rates will translate into better CD and bank interest rates? I remember 9% CDs. Those days are long gone, it seems.

Those should go up some but obviously not in tandem.

[RickFLM4]

Originally Posted by ASAP

Yea and why is the real question... insanity... they saw a tiny reaction by the market and panicked.

They cut rates in 2019 by 75 bps total. Not really that big of a deal and if they hadn’t cut them then, they would have just been cut by more in 2020 when COVID hit. I don’t think 75 bps cuts in 2019 are all that relevant to today and if referring to the long history of cheap money, it goes back way before those cuts. Generally in the absence of inflation, the Fed has kept rates low for a long time, not to mention other “accommodative” policies.

[Chick Webb]

Originally Posted by BRAKE!

One of the jobs it does is to monitor inflation/deflation by the way of an index called Consumer Price Index (CPI) among other indices.

As you note the Fed looks at a variety of data to get a sense of the direction of the economy, rates included. Their primary measure of inflation, though, is the Personal Consumption Expenditures (CPE) Price Index, excluding Food & Energy (aka PCE ex F&E). This is data that is generated by the Dallas Fed.

The latest PCE number, for April, is 4.9%. Obviously, that's considerably less than the headline CPE number of 8.6% that got released last week. It's always less than the headline CPI number, especially when food and energy (which are considered very volatile and thus more "noise" than "signal") are jumping around so much. Like the CPI, the PCE has been elevated for a while, but not nearly as much as the CPI, which helps explain (a little, anyway) why it's taken the Fed so long to act. Still way too late to the game, though.

Another thing people need to consider is the money supply and the Fed's ability to affect it. When the $2.1 Trillion give-away was passed last year there was no funding source behind it; the Fed just "printed" new money. It did that by buying newly issued Treasury bonds from the government and mortgages from Fannie/Freddie, and then of course the government injected all of that money into the real economy by writing everyone checks. That was more or less the case with the COVID relief in 2020, as well. All told, the money supply increased by 40% in two years. Think about that for a second. 40%. In just two years. Crazy, right? Did anybody not expect that to fuel inflation?

That massive expansion of the money supply is a BIG part of the problem and we're just starting to face up to it. Up until March(!) the Fed was still buying enough bonds/mortgages to at least maintain the size of it's so-called balance sheet, which stands at about $9 Trillion right now, up from $4 Trillion before the pandemic. They're now going to attempt to reduce the money supply without causing the entire economy to lock up due to a lack of liquidity. As of the beginning of this month they are starting to allow maturing bonds/mortgages to be paid back to the Fed and not buying new ones. They will take the funds that were used to pay them out of circulation. This will reduce the size of the Fed's balance sheet and remove those funds from the economy, "tightening" access to capital. Less capital, higher borrowing costs and lending standards, and growth slows.

All good, right? Well, maybe. Raising the funds rate AND reducing the supply of money in the economy at the same time is very tricky stuff, and due to the scale of it ($5 Trillion dollars!) nobody really knows what's going to happen. We could get a full-blown liquidity crisis and see massive failures like Leahman Bros, the double-whammy might drive us into a recession, or worse, stagflation. Something's gonna happen, though. And it might not be good.

The effects of both policies are already starting to spill over to other countries. Sri Lanka has already defaulted on its sovereign debt, and there are something like 14 countries that are similarly at risk. El Salvador's economy will collapse because they bought billions of dollars of Bitcoin, which is worth half or less what they paid for it, in an ill-considered attempt to shore up their failing local currency. Italy, Greece, Portugal, and Spain have seen the interest rates they have to pay to issue debt skyrocket, which threatens to throw the entire EU into another currency crisis (thus explaining the ECB's reluctance to raise rates, which will make it even worse). Hell, the Swiss Central Bank - the most staid, conservative sovereign bank on the planet - just did a surprise 0.5% rate increase overnight.

Meanwhile China's dropping rates and printing money to stimulate their Zero-COVID-stricken economy. Which might actually save the world's bacon; we'll see. So, yeah, it's a mess and could get messier. A LOT messier. What's that old Chinese curse? "May you live in interesting times"? Yeah, that's it.

[Chick Webb]

Originally Posted by M_Six

Is there any chance these higher rates will translate into better CD and bank interest rates? I remember 9% CDs. Those days are long gone, it seems.

Competition for deposits is what drives savings rates. With so much money out there right now there's no need to compete, so banks are going to keep rates low. In time, as liquidity decreases, banks will have to start competing for funds again, and they'll go up. Don't hold your breath, the Fed has $5 Trillion that it needs to bleed out of the economy. Even at their terminal rate of $90 Billion/month, it's going to be years before that happens. Best to stick with your favorite credit union and get a few more crumbs.

[M_Six]

Originally Posted by Chick Webb

Competition for deposits is what drives savings rates. With so much money out there right now there's no need to compete, so banks are going to keep rates low. In time, as liquidity decreases, banks will have to start competing for funds again, and they'll go up. Don't hold your breath, the Fed has $5 Trillion that it needs to bleed out of the economy. Even at their terminal rate of $90 Billion/month, it's going to be years before that happens. Best to stick with your favorite credit union and get a few more crumbs.

I figured as much. When I was young and dumb and broke, you could make decent money by buying long term CDs. Now we have liquid assets and they earn pennies. Although I guess that's better than the beating I'm taking with my retirement accounts.

[Pheonix]

Look into I Series Bond! There are lots of limitations but have been paying %9-13% since the late 90s.

[chassis]

ibonds are good. $10k per year per social security number purchase limit.

[2000cs]

Originally Posted by M_Six

I figured as much. When I was young and dumb and broke, you could lose less purchasing power by buying long term CDs. Now we have liquid assets and they earn pennies. Although I guess that's better than the beating I'm taking with my retirement accounts.

FTFY

[ryan stewart]

Originally Posted by chassis

ibonds are good. $10k per year per social security number purchase limit.

THIS.

You have to go through a rigamarol of getting credentialed at your bank but once thats up you can buy direct, just wish it was more money.

[M_Six]

I look into those. $10k per year per SSN means Wifey and I could stash away $20k/yr every year. Easily doable.

This seems almost too good to be true, though. I see you need to keep them at least 5 years to avoid penalties, but are there other gotchas?