3 Indicators that Impact Interest Rates

Posted by Chris on March 18, 2015

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Interest Rates Are Always Moving

Interest rates. They can drive you crazy. It may seem like they go up and down on their own, but there is a bit of a method to the madness. Indicators exist in the market that can help you predict what these rates are about to do.

If you’re thinking about buying a car, refinancing your home or have a big purchase around the corner it’s always in your best interest to understand market conditions in order to poise yourself for success. In this blog, we’ll look at how interest rates are set, what makes them fluctuate and some of the biggest economic indicators of an interest rate move.

While you should always consult your lender to get the most accurate information on rates and the market, these tips and tricks will help you have a better grasp of what to watch for!

How are interest rates set?

Interest rates have, historically, been set by either national governments or central banks. In the United States, the authority to make decisions on adjusting the interest rate is split between the Board of Governors of the Federal Reserve (also known as the Board) and the Federal Open Market Committee (also known as FOMC).

Essentially, the Board of Governors of the Federal Reserve decides on changes in discount rates, at the recommendations of the Federal Reserve Banks. The Federal Open Market Committee makes decisions on open market operations, including the desired federal funds market rate.

What makes rates fluctuate?

Interest rates can fluctuate regularly, and are affected by a wide variety of factors, including the following:

  • Political climate
  • Money supply
  • Savings rates
  • The bond market
  • Risks of investment
  • The economy
  • Taxes

The list goes on … But we all know interest rates play a huge role when you are borrowing money. Whether you are borrowing money or refinancing an existing loan, even a very small difference in an interest rate can make a huge difference in how much you end up paying for a big-ticket item.

Because interest rates fluctuate regularly, it is always important to have a general understanding of how the market is performing. But, how are you supposed to know when interest rates are going to shift? Are there any key economic indicators that you should watch for, to see if interest rates might be on the move?

Key Economic Indicators That Impact Interest Rates

Fortunately, there are a few things that you can watch for, which will help give you an idea when interest rates may soon be moving. Here are the top three things that you should watch out for:

#1 Gross Domestic Product. The Gross Domestic Product, or GDP, the total output of all goods and services produced by the labor pool and property in the United States, is considered by some to be the single most important economic indicator of interest rate changes.

A larger than anticipated increase quarter-to-quarter, or even an increasing trend can be viewed as inflationary, which can cause concerns with the Federal Reserve. As a result, they may feel the need to step in and raise interest rates, in an effort to slow or temper the overall growth. On the other hand, a negative growth or a downward trend may cause the Federal Reserve to lower the interest rates, in order to stimulate the economy and spur growth.

#2 Consumer Price Index. The Consumer Price Index, or CPI, is simply a measure of the average amount of change over time in prices paid by consumers for a fixed market basket of typical consumer goods and services. This tool is considered to be a key indicator of inflation, which can play a large role in setting and determining the interest rates.

A Consumer Price Index that is higher than expected is typically considered inflationary. Similar to the Gross Domestic Product, the inflationary status can lead the Fed to raise interest rates in an attempt to temper growth. Conversely, a lower than expected CPI can cause both yields and interest rates to drop.

#3 The Unemployment Rate. The federal government regularly issues an employment report, which provides information on the unemployment rate and the number of unemployed people by industry, occupation, reason for unemployment, and also length of unemployment.

Unlike other employment indicators, such as payroll employment, the unemployment rate is what is known as a lagging indicator, meaning that it does not necessarily change direction at the same time as the economy. If the unemployment rate is lower than expected, or if there is a downward trend, this can be considered inflationary – meaning that interest rates may be raised as a means to temper the growth.

There are plenty of other economic indicators and signs that you can keep an eye on, in order to better predict if and when the interest rates may make a shift, whether they are to be raised or lowered. You can also watch the payroll employment, which is even used to predict other economic indicators. Payroll employment is considered by some to be the most significant indicator of current economic trends every month, coupled with the unemployment rate.

Housing stats are another economic indicator that you can observe. As with the other economic indicators, a higher than expected increase in housing starts can be seen as inflationary, which can lead the Fed to raise interest rates.

You can also watch the consumer credit data, which tracks levels of consumers’ debt for both automobile financing and commercial banking credit. Both are considered to be good indicators of consumer spending. Keep in mind, however, that consumer credit data only has a small overall impact on interest rates.

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Topics: Mortgage 101