The announced additional rate of .75%, which now peaks at between 1.5% and 1.75%, was the largest increase in this interest rate since 1994. The financial challenge is of concern to economic and banking experts in Puerto Rico, because it results in a further increase in consumer spending, who are facing an upward spiral in the price of essential categories, such as gasoline and food.
What is it intended to achieve?
Economist Heriberto Martínez, explained that the message the Fed is sending to the financial markets is that the period of cheap money is over and that from now on it will be more expensive to borrow, which will cause people to start saving money.
“The Fed is looking to take liquid money out of the market. Now, if you want a loan to fix up the house, the interest rates are not going to be as low, so you have a better return by putting the money in a savings account, rather than making a home improvement,” he explained.
The change to interest rates means that the consumer will hold off on general spending, investments and all types of loans, which will have an economic impact on businesses and banking.
“For example, the businessman who wants to expand his warehouse or expand his vehicle fleet, instead of taking a commercial loan that could be 2% or 3%, is now going to pay 5% or 6%. Higher interest rates are intended to encourage savings and discourage investment. For the ordinary citizen, accessing credit – such as personal or commercial loans or lines of credit – will be more expensive,” he explained.
More expensive mortgages and investments
Mortgage banking and investment markets reflect changes that must be closely monitored to know how drastic the economic impact on the island will be after the Fed’s decision.
“Of course we are concerned about the effect of the interest rate hike, although we cannot predict how much it will affect us. We have to see how the markets – such as bonds and the stock market – react, but if interest rates rise, banking products – such as financing and lines of credit – will be more expensive,” said Pedro “Peter” Torres, president of the Mortgage Bankers Association.
When this financial scenario occurs, Torres explained that investors begin to move their money as a measure to safeguard their investments.
“Many put their stocks on sale and start investing in safer bonds as the market stabilizes. They look at stocks and how the volatile market reacts. Others have a higher level of loss tolerance and withstand more market pressure. It is a risk that each investor assumes,” added Torres.
The banker explained that the Federal Open Market Committee (FOMC) meets every six weeks with U.S. central banks to determine whether to raise interest rates, so he believes that the economic outlook will continue to change. He also indicated that the rate increase reported by the Fed yesterday was as expected.
“In six weeks we have to see how the inflation issue has been reacting to see if the interest rate hike has had an effect,” he said.
For economist Adrian Alós, the first sectors that will experience the increase in interest rates on loans are mortgages and businesses.
“People who have mortgages with variable interest rates will feel the impact. Fixed rates for new loans will also be more expensive. On the other hand, the individual who wants to open a business, who depends on a loan or line of credit to do so and who already has conflicts to get the goods that are more expensive, is going to be directly affected. The prices of many professional services are also going to go up,” Alós stressed.
As he understands it, the Fed is trying to reduce aggregate demand in the economy to control inflation, so it is being aggressive as it sees external factors that they thought would be resolved in a short time – such as supply chain problems and the Russia-Ukraine war – are still present.
“Expect to see higher inflation rates during 2022 and 2023 as there are several factors that are out of our hands such as the price of oil. Further accelerated increases are expected in interest rates which rose .75%; they are projected to reach 3.4% by the end of the year,” Alós informed.
According to Martinez, the tool most used by the Fed to deal with inflation is to raise interest rates, which he believes ultimately affects ordinary citizens.
“Where this has an impact is on job creation, citizens’ purchasing power and the possibility of increasing salaries. Who ends up paying for this monetary policy to deal with inflation are working families. In the short term, there will be more complicated times for citizens”, he warned.
The economist expressed concern because, in his opinion, U.S. financial experts are not sure that this decision will have the desired effect and be as forceful as it was in previous decades.
“It is different now because the inflation problem is not 100% linked to internal dynamics of the economy or to failed monetary policies. Part of the inflation is linked to the pandemic and the geopolitical situation in Russia and Ukraine, which create distortion in the productive sector and distribution chain,” explained Martínez.
Impact on credit cards
Eli Sepúlveda, executive vice president of Banco Popular’s Commercial Credit Group, said that “the immediate effect is that optimism begins to dim a little and people start to be more cautious with their investments, expenses and short-term plans”. He added that the Fed “must manage the situation with subtlety to slow consumption, but not so hard as to stop it”.
For the banker, the rise in interest rates will affect credit cards and businesses first, followed by all types of borrowing products.
“Credit cards are the most tied to fluctuating rates. With high interest rates, consumption is discouraged because it costs more. Some segments will have a more immediate effect than others, but as rates rise, all will be affected…. such as car loans, mortgages, etc. The commercial sector, in which many clients have credit facilities with fluctuating rates, is impacted faster and the dilemma to decide begins, because it will cost the merchant more to expand, make improvements or have more inventory,” he added.