“The Federal Reserve is answerable to no one.”
— Ronald Reagan
The Federal Reserve is raising interest rates at a blistering pace, sending shock waves through the economy.
In the span of a few months, rate increases have turned optimism to outright concern. With GDP now declining in consecutive quarters, one would think the Fed would pause. However, in their July meeting, they called for more aggressive hikes through the end of the year.
The Fed’s plan to gamble with the country’s economic future may not pay off. In June, the Fed raised its benchmark interest rate by 75-basis points for the first time in nearly three decades. Despite that record increase, inflation still went up to a new high of 9.1 percent.
And on July 27, the Fed raised rates another 75-basis points. Pressed over whether central banks now had a better grasp of price-setting dynamics, Federal Reserve Chairman Jerome Powell responded, “We now understand better how little we understand about inflation.”
Why is the Federal Reserve Acting Now?
The answer is record inflation.
The Federal Reserve once called inflation “transitory.” It was a pandemic hangover that would work itself out. Then, they called it “elevated” and issued average interest rate hikes.
After inflation hit a 40-year high of 8.6 percent in May, Powell vowed to tame it at all costs. He declared, “inflation is much too high.”
What Caused Inflation?
There has been a perfect storm of events fueling the skyrocketing inflation; the war in Ukraine, supply chain snarls, and pent-up demand from the pandemic are all contributors.
The Biden administration may deny it, but massive government spending during the pandemic is a primary cause of today’s oppressive inflation.
Why Aggressive Interest Rate Hikes?
The Fed’s only real tool to fight inflation is raising interest rates. Raising rates causes higher lending costs. This makes businesses and consumers borrow and invest less. Businesses may stop hiring or lay off workers.
When consumers have less discretionary spending money, businesses’ revenues and profits decrease. Higher interest payments also encourage people to save money. This reduces the supply of money in circulation.
These factors can lower inflation and moderate economic activity—a.k.a. cool off the economy.
Brace for a Hard Landing
Rising interest rates slow economic growth by design. The fear is that the Fed’s ‘stop inflation at any cost’ plan will do more than slow growth. It may bring the economy to a dead stop, slamming it into recession.
The chance of recession rises with every interest rate hike.
According to a recent Reuters poll, economists give a 40 percent chance of the U.S. entering a recession, up from 25 percent in June. Meanwhile, Citigroup forecasts the odds of a global recession are 50 percent.
The possibility of avoiding a recession and achieving a “soft landing” is looking slimmer by the day.
Interest Rates, the Stock Market, & Retirement Funds
Higher interest rates can have a disastrous effect on retirement funds. This is because many retirement funds are driven by stock performance. Higher interest rates can lower earnings and stock prices.
If it looks like a company is cutting back on its growth or is less profitable, its stock price will most likely go down.
Also, higher interest rates can result in less money available for consumer spending. Reduced consumer and business spending can both lower the value of a company’s stock.
If the stock prices of enough companies go down, then key indexes, such as the Dow Jones Industrial Average and S&P 500, can also go down. Index funds, essential components of many retirement accounts, go down as well.
Used by retirement funds to build wealth, growth stocks suffer tremendously from interest rate hikes. They rely heavily on capital for future business expansion. When that capital becomes too expensive, investors leave them for safer assets.
How to Defend Against Spiking Interest Rates
The best way to mitigate the impact of rising rates is to diversify your asset allocation. But this economy is upending traditional diversifiers like bonds and savings.
Bonds are not proving to be the best hedge against rising interest rates. They are very sensitive to interest rate changes. The market prices of existing bonds immediately decline when rates rise. The price drop makes them more competitive against new bonds with higher interest rate payments. In March, the bond market suffered its worst quarter in more than 40 years.
A potential benefit of rising interest rates is that savings accounts and certificates of deposits increase their return. But investors must keep inflation in mind. The inflation rate can outpace the savings rate. And with today’s high inflation, consumers should do the math and see if they are actually saving anything at all.
Against soaring inflation, record interest rates, and an unofficial recession, gold is proving to be a safe haven asset.
Some market watchers believe that higher interest rates send gold prices lower. Since gold is a non-interest yielding asset, rising interest rates can make it seem less appealing. But a long-term look through historical data reveals that no relationship exists between rates and gold. Like most basic commodities, it is a function of supply and demand in the long run.
A study of the massive 1970s bull market for gold reveals that gold rose to its all-time high price of the 20th century when interest rates were skyrocketing. By 1980, interest rates had more than quadrupled, rising as high as 16 percent. In that same period, the price of gold mushroomed from under $50 an ounce to a once unimaginable price of $850 an ounce. The price of gold is ultimately not a function of interest rates.
A toxic blend of pandemic, global conflict, and reckless government spending has created the highest inflation in 40 years.
Recognizing the threat of inflation, the Federal Reserve has vowed to raise interest rates as fast and as high as they must to bring it under control. They will do this even if it means collapsing the economy, creating a recession, and wiping out retirement funds.
Investors interested in protecting their portfolios should consider precious metals. A Gold IRA is specifically designed to shield 401(k)s and IRAs from the ravages of high interest rates. You can contact American Hartford Gold to learn more today.
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