Inflation: The New Federal Reserve Policy and What this Means

Photo of the Federal Bank by WSJ

The Federal Reserve is one of the most important pieces of our economy, focusing on enacting monetary to keep the economy in balance. Yesterday’s announce from the Central Bank noted that the bank would “tolerate inflation moderately above 2%”. On average, inflation is slightly above 3% per year.

What does this mean?

With current monetary policies geared towards stimulating the economy coupled with near 0% interest rates, inflation has already begun to climb. This new development could lead to a longer period of low interest rates. This is great news for borrowers, small businesses, and big businesses. On the downside, this could put a temporary dent in revenue for large banks.

How does this impact You?

Inflation is an investment killer for those with safe investments such as bonds, low volatility stocks, and savings accounts. While the most generous savings and CD yields were above 2% pre-covid, extremely low interest rates have cause yields to drop below 0.5%. If you are only investing in bonds and savings accounts, this could be disastrous. For example with a bond that is currently only providing a 0.8% yield and annual inflation of 3%, you are actually losing 2.8% of your money’s purchasing power.

This new development is extremely important for homeowners, home buyers, and others who plan on taking a long term loan. Because loan interest rates do move in conjunction with the Federal
Reserve rate, current borrowing rates are low and make it more affordable to purchase a home.

Ex. You are purchasing a $500,000 home

4% interest rate for 30 year fixed rate loan

Monthly Payment: $2,387

Total Paid after 30 Years: $859,348

3% interest rate for 30 Years

Monthly Payment: $2,245

Total Paid: $808,280

As you can see, even a half a percent drop in mortgage interest rates can help you save over $50,000 over the life of the mortgage. With current mortgage rates hovering around 3.14% and expected to decline even further, this a great opportunity to save a boatload of money by refinancing.

How does this impact the stock market?

With the cost of borrowing near all time lows, companies can look to increase debt and invest in growth. Even with the uncertainty caused by the pandemic, there is a strong possibility that blue chip stocks will continue to grow for the next several years. Companies can focus on investing in growth and leverage their debt to further expand. I think low interest rates could cause the stock market to continue to rise in the next year.

What You Can Do?

With interest rates at all time lows, now is the best time to refinance personal, student, or mortgage loans. You can save a good chunk just by lowering you interest rate half a percent from 4% to 3.5%. Small decreases can help put more money back into your pocket. This is also an important time to rethink your savings strategy. With the most of the stock market in overdrive, it might be time to consider investing in income or dividend stocks and limiting risk in growth and tech stocks. If you don’t invest and only save, I would strongly suggest looking at churning bank account signup bonuses and other bonuses to create income, otherwise strictly saving will cause your money to devalue over time.

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