How the Fed's Decision Will Impact You

There are some things that market professionals and analysts find endlessly fascinating, and yet to most people, those things are often incomprehensible and seem irrelevant to their daily lives. The minutiae of Fed policy would be one of those things. Discussions about any "hawkish" or "dovish" language in a statement, or by how many basis points the Fed will raise or lower rates, are confusing enough. But when we get to talk of "quantitative easing," or QE, most people’s eyes just glaze over.

Behind all the jargon, however, important decisions are being made that will impact everyone in this country, and maybe even the world. So, in plain terms, what can we expect from the Fed this week and how will it affect ordinary Americans and the average investor?

Today, the Fed’s main policy setting body, the Federal Open Market Committee (FOMC) starts a two-day meeting, after which they will announce changes to interest rates and other monetary policy. Most economists think they know what that committee will do: they will raise rates by fifty basis points, or half of one percent, while also probably announcing that they will be selling some of the bonds that they have been buying since the end of the recession in early 2009.

Those two things may sound a bit inside baseball, but they will have a profound impact beyond the markets.

Historically speaking, raising rates by half a percentage point is no big deal. As a 2020 study by the Bank of England shows, interest rates have been trending downwards for the last 700 years, and a half point hike this month won’t change anything in that sense. What does matter is where rates will be tomorrow or next month, as opposed to where they are today. Higher rates discourage borrowing, whether for spending or investment, and therefore they slow economic activity. It will make credit card debt and other forms of debt more expensive. The more people pay to service their debt, the less they have to spend elsewhere. Critically in the current environment, it will also push mortgage rates higher.

That second impact will be even more exaggerated if the Fed does announce that they will begin selling some of the bonds that they have been buying. That buying was designed to keep longer-term interest rates low and has included massive purchases of packaged-up mortgages. It had the desired effect, but also led to a big increase in house prices all around the country as mortgages got cheaper. Reversing the policy and actively selling those mortgage bonds risks sending mortgage rates significantly higher, reducing demand for housing and thereby causing a significant decline in house prices.

There is some talk about whether or not the Fed’s policy changes will cause a recession, defined by economists as two successive quarters of negative growth. That may or may not happen, but after a sustained period of strong growth and with a massive labor shortage, even if it does happen, a recession won’t have a massive impact on most people unless it lasts a lot longer than two quarters. However, a big drop in housing prices will.

My dad always used to say that house prices only matter twice: when you buy your first one, and when you die. There is some truth to that, but home equity is the most significant store of wealth for most people. Reducing that makes people feel poorer, and people who feel poorer cut back on spending.

When you hear reporting of the Fed’s announcement later this week, focus on the big picture. If they raise rates as expected and also signal aggressive selling of assets, it will impact you directly by increasing the cost of any debt you have, and probably by reducing the value of your home. Those two things will be far more important than any short-term negative impact those decisions may have on the stock market.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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