The U.S Fed has increased interest rate by 0.5% — the highest since 2000. Here’s how the interest rate hike will affect you.
The S&P 500 has been off to a bad start in the first four months of 2022, closing down 13.3% at the end of April. In fact, it’s the worst in 83 years (since 1939 to be exact).
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The S&P 500 isn’t the only major index that fell
The Nasdaq Composite Index (COMP), which tracks stocks listed on the Nasdaq stock exchange, fell by 21.2%, its biggest drop since 1971.
Meanwhile, the Dow Jones Industrial Average (DJIA) closed off 9.3% at the end of April, marking the biggest decline for blue-chip companies since 2020, when the index fell 14.69% during the height of the COVID-19 pandemic.
What went wrong and caused the drops?
There were a few contributing factors:
For starters, the first four months of 2022, in particular April, have been rough for some of the biggest tech companies, which had dismal quarterly results and guidance.
Netflix, for instance, saw its first subscriber drop for the first time in more than 10 years, losing 200,000 subscribers in Q1 2022. The video streaming giant has also projected that it will lose 2 million subscribers in the second quarter of this year, suggesting that it will face stiffer competition from other on-demand video streaming providers.
As a result, the company saw its shares drop to a 4-year low, and it also lost US$54 billion of market capitalisation in a day, the largest single-day decline in its history.
Meanwhile, the likes of Apple, Amazon, and Google parent company, Alphabet also reported softer Q1 results. As major indices like the S&P 500 and Nasdaq are dominated by tech companies, their decline has contributed to the market’s fall.
Shaky market sentiment due to lingering worries around the Russia-Ukraine war, COVID-19 pandemic, global economy, and rising inflation.
However, the biggest contributing factor to the sluggish performance was the anticipated rate hikes by the U.S Federal Reserve, which have since been announced to be 0.5%. This marks the highest Federal Funds Rate (FFR) increase in two decades (since 2000) and the rate is now in a range of 0.75% to 1%. Six more rate hikes are also projected to happen in 2022.
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Why did the U.S Federal Reserve raise its FFR?
The main reason for raising the FFR is to curb rising inflation, which has risen by 8.5% year-on-year in the U.S. By raising the FFR, it becomes more expensive to borrow money, including home loans and mortgages.
Those who don’t want or can’t afford higher payments will postpone taking a loan or avoid taking it altogether, and will instead save money. This results in lower money circulation which in turn lowers inflation and reduces spending, helping to ‘cool’ the economy.
For example, a family who’s shopping for a home may delay buying a home or take a smaller mortgage so that they can lower their monthly payments when interest rates rise. The weaker demand will then cool off home prices.
How has the market responded?
Immediately after the announcement of the rate hike on 3 May, the U.S markets rebounded sharply, posting their best performance in two years: the S&P 500 rose 3%, the Nasdaq grew 3.2%, and the Dow Jones rose 2.8%. All 11 sectors of the S&P 500 were also positive.
However, all those gains were short-lived as the market came tumbling down the very next day; the Dow Jones fell 3.12%, the Nasdaq dropped 4.99%, and The S&P 500 dropped 3.56%, its second-worst day of the day of 2022.
Tech and e-commerce companies were the largest hitters; Meta and Amazon fell nearly 6.8% and 7.6%. Microsoft dropped about 4.4.%, Apple sank nearly 5.6%, and Shopify fell by nearly 15%. The declines also dragged the Nasdaq to its lowest closing since November 2020.
How will the rate hike impact you?
After the historic rate hikes, interest rates will go up which means that it becomes more expensive to borrow money. This means higher interest rates for home loans, mortgages, car loans, personal loans, and credit cards.
How credit cards will be impacted
Your credit card interest rate will also increase, so expect your annual percentage rate (APR) to jump. Remember that credit cards have the highest interest rates among all your debts, and the average interest rate is 25%. So if you have an outstanding balance, it will get more expensive to clear them.
If you’re struggling with paying off your debt, you may want to take a personal loan, or take a balance transfer to consolidate all your credit card debts to pay them off in interest-free instalments.
How stocks will be impacted
Businesses will find borrowing money and doing business more expensive, which may result in lower revenues and earnings. With lower earnings, a company’s stock value and growth will also be impacted. Businesses will also find it harder to borrow money and invest to expand their growth.
Meanwhile, the increase in interest rates might also affect market sentiment. Investors might sell their shares and resort to defensive investments such as bonds to protect themselves during a market downturn. For a longer-term investing portfolio, analysts suggest allocating a portion in value stocks and value funds due to the higher probability of outperforming inflation.
All the volatility and huge sell-off have left stocks undervalued. According to Morningstar, U.S stocks are trading at 12% below their value, including those in the communications sector such as Meta Platforms and Alphabet.
How mortgages will be impacted
In Singapore, the benchmark for home loan and mortgage rates is based on the Singapore Interbank Offered Rate (SIBOR) and Singapore Overnight Rate Average (SORA).
Unlike most central banks around the world, the Monetary Authority of Singapore (MAS) combats inflation by raising its exchange rate. This appreciates the Singapore dollar to reduce import-led inflation. This also means that banks in Singapore do not need to increase interest rates.
That said, Singapore’s interest rates are still determined by the global interest rate. According to one expert, a 0.5% rate increase by the U.S Fed will increase the 3-month SIBOR and SORA by between 0.3% to 0.4%.
As such, Singapore households can expect to pay more money to service their existing mortgages going forward, particularly those with floating-rate home loans.
“Households may be impacted by the rising cost of mortgage and other loans on top of the general rise in cost of living that they are currently already facing,” said Mr Christopher Wong, Southeast Asia portfolio strategist at Fidelity International, as quoted by CNA.
How it will impact your savings in bank accounts
However, things aren’t all gloom and doom. If you have money parked with a bank, such as a high-interest savings account or bank deposits, you’ll stand to earn higher interest. However, the rates are still likely below the inflation rate.
If you want to beat the inflation rate, these investments can help you hedge against inflation.
Read these next:
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By Kang Yen Joon
In my past life, I was always broke (I still am) because of a lack of financial literacy. These days, I publish a few posts every week* on personal finance to help you manage your money better.
*I mean, I’ll try