The fast rising Interest Rates explained.

Unless you are living under a rock, then you know that the current overall economy isn’t doing that well. No matter the spin coming from the White House and its aligned corporate media telling you other wise, here is the truth.

Three things are impacting the economy. Well, four if you count the overall incompetence at the highest levels of government. But I digress.

The three things are interest Rates, inflation, and the unspoken truth about the unemployment rate.

All three of these topics are deep. And to keep this post to a minimum, I want to talk about interest rates and its impact on you personally.

Interest rates:

Where do interest rates come from?

The Federal Open Markets Committee (FOMC) sets the federal funds rate—also known as the federal funds target rate or the fed funds rate—to guide overnight lending among U.S. banks.

Fed funds is a key tool that lets the central bank manage the supply of money in the economy. That’s because it influences what banks charge each other, which informs the rates they charge you and their other customers.

When you put you money in a bank. It allows that bank to then lend that money out to other people in the form of loans and credit. The bank gives you an interest of virtually zero on the money they then lend out to others. This is another topic for another day. But keeping your money in a checking or savings account is really dumb. You are allowing the bank to make a lot of money off your deposits while you earn almost nothing.

Regulators manage the banks and will only allow a certain percentage of the banks deposits to be lent out. So the amount of money they have in reserves (actually holding on to) versus being lent out is constantly changing. Because it is changing on a daily basis, banks will often borrow money from other banks to make sure they keep the amount of reserves the regulators require.

One of the common reserve requirements is 10% of deposits must be kept in reserves. That means the bank can lend out the other 90% for credit and loans. Sounds crazy right? To me it does? However, without this credit businesses, mortgages, cars, etc. wouldn’t get funded.

So if a bank has $500 million in deposits. They must keep 10%, $ 50 million in reserves. Meaning that they can lend out $450 million of that money in loans and in credit.

We have watched interest rates rise in the last 14 months by five basis points. One of the fastest times in history. The government does this to slow down the economy. We have talked about high inflation here before. Check out this post to revisit that conversation and what it means. Also this post.

So what does this mean?

A sudden or significant increase in interest rates can lead to a variety of challenges for banks, especially if they have significant exposure to interest rate-sensitive assets such as long-term fixed-rate loans or investments. If interest rates rise quickly, these assets may become less valuable, which can put pressure on a bank’s capital and profitability.

Part of most banks portfolios are bonds.

Bonds are financial instruments that pay a fixed interest rate over a certain period of time and return the principal amount at maturity. When interest rates in the broader economy rise, newly issued bonds start to offer a higher rate of interest to investors, which makes them more attractive than existing bonds with lower interest rates.

As a result, the demand for existing bonds decreases, leading to a decrease in their price. This is because investors who own existing bonds with lower interest rates would need to lower the price of their bonds to make them competitive with the newly issued higher interest rate bonds. This is known as the opportunity cost of holding a bond.

For example, suppose you own a bond that pays a fixed interest rate of 3% per year, and interest rates in the broader economy rise to 4%. In that case, investors can buy a new bond paying 4% interest, making your 3% bond less attractive. To make your bond competitive, you would have to sell it at a lower price to give the investor a higher yield, which compensates for the lower interest rate.

When interest rates rise, bond prices fall, and when interest rates fall, bond prices rise. This inverse relationship between bond prices and interest rates is called interest rate risk. It’s important to note that the magnitude of the change in bond prices depends on the bond’s duration, which is a measure of its sensitivity to interest rate changes. Bonds with longer maturities or durations tend to be more sensitive to interest rate changes than bonds with shorter maturities or durations.

If interest rates rise due to inflation, it can lead to higher loan defaults and decreased demand for credit, which can also negatively impact banks. Finally, a rise in interest rates can also lead to a general economic slowdown, which can affect banks’ ability to generate new business and increase their credit risk.

As the banks continue to get more and more pressure on them because of the rising interest rates, the overall economy is impacted significantly.

  1. Increased borrowing costs: Higher interest rates lead to increased borrowing costs for individuals, businesses, and governments. This can make it more expensive for them to finance projects, which can lead to reduced borrowing and investment and slower economic growth.
  2. Reduced consumer spending: As borrowing costs increase, consumers may be less likely to take out loans to finance purchases such as cars, homes, or other big-ticket items. This can lead to a reduction in consumer spending, which can slow down economic growth.
  3. Appreciation of the currency: As interest rates rise, demand for a country’s currency may also increase as investors seek to invest in higher-yielding assets. This can lead to an appreciation of the currency, making exports more expensive and imports cheaper. This can hurt export-oriented industries and increase the trade deficit.
  4. Slower inflation: Higher interest rates can help to slow down inflation by reducing demand for goods and services. This can help to stabilize prices and prevent runaway inflation, which can have negative effects on the economy.
  5. Increased savings: As interest rates rise, saving becomes more attractive as consumers and businesses seek to earn higher returns on their deposits. This can lead to an increase in savings and a decrease in spending, which can slow down economic growth.

I don’t intent on being gloom and doom here. Instead I want to inform you of the reality of what is going on in the economy so my readers can make informed decisions on what they do with their money.

I personally am taking advantage of treasury bonds, these are short term investments that are paying historically high returns right now. Check out this post here for more information on this.

I am looking for cash flowing real estate deals. And lastly, I am hoarding cash so I can capitalize on deals that may are getting negatively impacted by all of the issues within the economy right now.

To your success and your future.

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