Mike Larson: First things first: The Federal Reserve did exactly what I predicted, before it was fashionable to predict it. They agreed to lop another $10 billion off the QE bond-buying program at this week’s meeting, slashing it to $65 billion.
Policymakers also strongly implied they will continue to reduce their bond buying going forward. That step, in turn, sets the stage for actual short-term interest rate hikes. I continue to believe those will begin earlier than most market players believe, and I would start preparing for them.
But what the Fed did this week is nothing compared to what happened elsewhere in the interest rate markets.
Just imagine that you woke up one morning and the Fed had jacked interest rates up by 425 basis points overnight. That’s 4.25 percentage points — enough to raise the federal funds rate from its current 0 percent to 0.25 percent range to around 4.5 percent.
If you’re not already aware, the overnight rate serves as a benchmark for the prime rate. And the prime rate is the benchmark that many variable rate loans are tied to. So if you had a variable rate credit card at the Bankrate.com national average rate of about 11 percent, it would almost immediately surge to 15.25 percent.
Assuming you had a $10,000 balance on your credit card at 11 percent, it would take 11 years and two months to pay off, assuming a $400 monthly payment along the way. You’d pay around $2,914 in interest over that time. At a rate of 15.25 percent, it’d take you one year and three months longer to pay that balance off, and it would cost you $4,561 in interest. That’s more than $1,600 in extra interest costs.
|The central bank in South Africa raised rates by 50 basis points mere hours after Turkey hiked its benchmark rate.|
Your home equity line of credit? Its rate would surge from around 4.8 percent to just over 9 percent.
Any variable rate business loans you might have outstanding? Up, up, up!
With longer-term mortgages, there’s no telling exactly how much rates would go up because they don’t move on a 1-to-1 basis with overnight rates. But it’s a safe bet that they would rise at least 100 to 200 basis points.
That would drive the monthly payment on a $300,000 mortgage from around $1,490 (at a recent average rate of 4.33 percent) to a whopping $1,863. That’s more than $370 more a month … every month … for the next three decades.
Why am I bringing all this up?
Because the Turkish central bank was just forced to hike its overnight rate to 12 percent from 7.75 percent. It also had to more than double a separate overnight borrowing rate to 8 percent from 3.5 percent. So you can only imagine how the local economy there is going to react.