Kavan Choksi / カヴァン・チョクシ Discusses the Impact of Interest Rate Changes by the Federal Reserve

Kavan Choksi / カヴァン・チョクシ Discusses the Impact of Interest Rate Changes by the Federal Reserve

The Federal Reserve often cuts interest rates when the economy shows signs of struggle. As interest rates go down, so does the borrowing costs. This ultimately encourages businesses to take out more loans to expand production and hire more people. This approach works in reverse when the economy is hot. As per Kavan Choksi / カヴァン・チョクシ, changes in interest rates have many real-world effects on the ways businesses and consumers can access credit to make necessary purchases and plan their finances

Kavan Choksi / カヴァン・チョクシ talks about the impact of interest rate changes by the Federal Reserve

Lower interest rates have a direct impact on the bond market. After all, it causes yields on everything, right from corporate bonds to U.S. Treasuries to fall, and hence they become less attractive to new investors. Bond prices typically move inversely to interest rates. This basically means as interest rates fall, the price of bonds goes up. In a similar manner, an increase in interest rates would lower the price of bonds, thereby impacting fixed-income investors in a negative manner. People are also less likely to borrow or re-finance existing debts when the interest rates rise.

An increase in the Fed’s rate is likely to fuel a jump in the prime rate almost immediately. The prime rate is commonly known as the Bank Prime Loan Rate and it represents the credit rate that banks extend to their most credit-worthy customers. This is the rate on which other forms of consumer credit are based. Higher prime rate implies that banks shall elevate fixed- and variable-rate borrowing expenses when assessing risk on less creditworthy consumers and companies.  Banks typically determine how creditworthy other individuals are on the basis of their risk profile, working off the prime rate. Rates for credit cards and other loans are impacted as they require extensive risk-profiling of consumers seeking credit for making purchases. Short-term borrowing shall have higher rates in comparison to the ones considered long-term.

As per Kavan Choksi / カヴァン・チョクシ, an uptick in the prime rate also causes an increase in the money market and certificate of deposit (CD) rates. This should typically boost consumer and business savings as they are able to generate a higher return on their savings. However, it can also cause anyone with a debt burden to instead seek ways to pay off their financial obligations in order to offset the higher variable rates tied to credit cards, home loans, or other debt instruments.

An increase in interest rates raises borrowing costs for the U.S. government, leading to a higher national debt and larger budget deficits. The Committee for a Responsible Federal Budget estimates that the total budget deficit from 2022 to 2031 will reach $12.7 trillion. Raising interest rates by just half a percentage point would add $1 trillion to the deficit. The national debt, as a percentage of GDP, is projected to be 107.5% by 2031. If rates were 50 basis points higher, this would rise to 110.6% of GDP.