The Federal Reserve's meeting of the Federal Open Market Committee (FOMC) is set to take place on Tuesday and Wednesday of this week, with the central bank widely expected to raise interest rates upon the meeting's conclusion. This would be the first rate hike since Jerome Powell took the helm of the Fed.
Here's what it means when the Fed "raises rates," what it could mean to you as a consumer, and how the results of the Fed's meeting could affect the stock market.
What the Fed is expected to do
When you hear about the Federal Reserve "raising rates," this is referring to the Federal Open Market Committee adjusting its target Federal Funds Rate, which is the basis for many other commonly used interest rates. For example, the prime rate is directly linked to the Federal Funds Rate, and the prime rate is used to determine things like credit card APRs and home equity line of credit interest rates.
Currently, the Federal Funds Rate has a target range of 1.25% to 1.50%, which is still on the low end on a historical basis.
Although the Fed has the ability to raise rates as much as it sees fit, it generally does so by 25 basis points at a time. So, the expected result from this week's Fed meeting is a new target Federal Funds Rate range of 1.50% to 1.75%.
How will a rate hike affect you?
The short answer is that a Federal Reserve rate hike tends to drive consumer interest rates higher. However, it's a bit more complicated than that.
Some interest rates move in tandem with the Federal Funds Rate. Credit cards are the biggest example. A 0.25% increase in the Federal Funds Rate will produce the same increase in your credit card's APR (unless you have a temporary promotional interest rate). In other words, a 17.99% APR will become 18.24%, shortly after the Fed's announcement. The interest rates charged on home equity lines of credit (HELOCs) are also tied to the Federal Funds Rate via the prime rate, and will also increase or decrease along with the Fed's interest rate activity.
On the other hand, some consumer interest rates aren't directly tied to the Federal Funds Rate, so the relationship is a bit more difficult to predict. Auto loans are a good example. Although the rates offered on auto loans tend to move in the same direction as the Fed's rate activity, it isn't a perfect correlation. Mortgage rates are another example, and, in recent history, mortgage rates haven't moved nearly as much as the Fed's rate hikes might lead you to believe.
A big question from consumers is, "Will this finally translate into more interest in my savings account?" Unfortunately, this is another unpredictable correlation. Specifically, savings interest rates do tend to rise when the Fed raises rates, just to a lesser extent. And during the current rate-hike cycle, consumers are yet to receive much of a benefit at all.
The most important things for investors to watch
It's considered to be a virtual certainty that the Fed will hike rates by a quarter-point when it announces its decision on Wednesday, so this is unlikely to move the market much. According to CME Group, analysts say that there's a 95% chance the rate hike will happen as expected. In other words, the upcoming rate hike is already priced in to stocks, for the most part.
On the other hand, what could significantly move markets is if the forecast for future rate hikes changes. Along with the Fed's statement of an interest rate hike, we'll also get a look at the Fed's expectations for rate hikes over the next few years.
The projections as of the last rate hike in December called for a total of three quarter-point rate hikes this year, two more in 2019, and another two in 2020. One change that has been widely speculated is that the Fed could raise rates four times this year due to inflation concerns, and if Wednesday's projections show that this is indeed the new expectation, it could certainly rattle the stock market as higher rates are generally seen as a negative catalyst for stocks.
The Fed's economic outlook -- specifically the expectations for unemployment and inflation -- could also move the market. Recently, bond yields have been under upward pressure mainly on inflation fears, so if the Fed's current 1.9% inflation expectation is increased, it could be a catalyst for another leg up.