The Federal Reserve just raised interest rates — what does it mean to investors?

Here’s what investors and consumers need to know.

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This article was originally published on All figures quoted in US dollars unless otherwise stated.

As was widely anticipated, the Federal Open Market Committee (FOMC), which is the policy-making arm of the Federal Reserve, announced a 50-basis-point hike to the federal funds rate. Since a basis point is equal to 0.01 percentage points, this means that the benchmark rate has risen from a target range of 0.25%-0.50% to 0.75%-1.00%.

If you didn't fully understand that first paragraph or what it means to you, don't worry. Here's a rundown of what this rate hike means in simple terms, what it could mean for investors, and what to expect going forward.

Here's what the Fed's rate hike means

The Federal Open Market Committee has two main functions -- to maximize employment and control inflation. And with the unemployment rate sitting at a low 3.6%, the clear goal of this move was to get inflation in check -- after all, inflation is running at its highest rate in four decades, and many consumers are feeling the pain.

Without getting too deep into the weeds on an economic discussion, the general idea is that higher interest rates help slow down economic activity. However, raising interest rates too fast can result in a major shock to the economy, so the Fed tends to raise rates incrementally (like it did today) to gradually slow down inflation closer to the Fed's 2% target.

For consumers, the important thing to know is that some interest rates that affect Americans are directly tied to the federal funds rate. For example, if you have a credit card, you can bet that its standard interest rate for purchases will rise by 0.50% in response to the Fed's latest move. Adjustable-rate mortgages and HELOCs are other types of interest rates that typically move according to the benchmark.

On the other hand, fixed-rate mortgage interest rates and auto loan rates, among others, are not directly tied to the Fed's moves. After all, the average 30-year mortgage rate has already increased from 3.29% to 5.55% since the end of 2021, despite the FOMC only raising rates by 0.25% in that time. And for savers, the interest rates you get paid on savings deposits aren't tied to benchmark rates either.

What could it mean to investors?

When it comes to the rate hike itself, the impact on your investments is likely to be minimal. This was a widely expected rate hike and was already priced into the market. Sure, if a company relies heavily on borrowed money that happens to be tied to the federal funds rate (like a credit line), it could have a bit of an impact on interest expense, but there's a reason the stock market barely budged after the rate hike was announced -- the market saw it coming.

What to expect going forward

Here's the most important takeaway for investors. It's not what the Fed just did that moves markets. It's what the Fed is expected to do next.

According to the CME Group's (NYSE: CME) FedWatch tool that analyzes futures markets, the current expectation is for another 75-basis-point rate hike when the FOMC meets in late June. By the December meeting, the current median expectation is for a federal funds rate of 3%-3.25%. And in a year from now, at next May's meeting, the most likely scenario is currently seen as a target range of 3.5%-3.75%. If these expectations change significantly in the months leading up to future meetings, it could certainly have a big impact on markets.

It's also important to pay attention to commentary by Fed officials, particularly FOMC Chair Jerome Powell. His speeches have the ability to quickly alter the market's expectations about future rate hikes.

The bottom line is that this rate hike was widely expected, but there's a wide range of potential outcomes going forward. It depends on how aggressive the FOMC wants to get, and how quickly inflation starts to cool off in response to rising interest rates.

This article was originally published on All figures quoted in US dollars unless otherwise stated.

The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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