President Joe Biden signed the Inflation Reduction Act into law on August 16th, 2022 after it passed in Congress.

This new law is a trimmed-down version of the president’s $1.75 trillion Build Back Better Plan. This act was signed into law amid historically high levels of inflation.

The Consumer Price Index (CPI), the benchmark that measures inflation pegged July inflation at 8.5%. Though the July data suggests that prices appear to be cooling off, US inflation is still at a 40-year high. 

The real question on the minds of Americans is the potency of the bill to bring inflation down and lower living costs. In this article, we look at how the newly signed Inflation Reduction Act affects your pocket, and if it brings much-needed relief that consumers need at this time.

 

 

What is the Inflation Reduction Act?

The Inflation Reduction Act of 2022 is a law that aims to curb inflation by reducing the deficit, lowering prescription drugs, and investing in domestic energy production while promoting clean energy.  

It is a budget reconciliation bill sponsored by Democratic Senators Chuck Schumer and Joe Manchin. The bill was introduced as an amendment to the Build Back Better Act which was reduced and comprehensively reworked from its initial proposal after receiving opposition from Manchin.

The law will raise $737 billion and authorize $369 billion in spending on energy and climate change, $300 billion in deficit reduction, three years of Affordable Care Act subsidies, prescription drug reform to lower prices, and tax reform.

 

 

5 Ways the Inflation Reduction Act Will Impact Your Money

1. Inflation

There have been varied reactions to the Inflation Reduction Act, but one stance that many financial analysts appear to agree on is that its title is misleading. By this, the policies enshrined in the law are unlikely to put a lid on rising prices - at least soon. 

The bill levies tax hikes and regulations against manufacturers, which will restrain supply, diminish production, and increase prices. The University of Pennsylvania Wharton Budget Model estimates that the Inflation Reduction Act will fail to live up to its name — having no impact on lessening inflation.

The Tax Foundation stated that the bill "may worsen inflation by constraining the productive capacity of the economy."

The fiscally conservative think tank estimated that the bill would result in a loss of 30,000 jobs and a 0.1% reduction in GDP while resulting in $304 billion of additional revenues, which would go towards deficit reduction.

 

2. Healthcare

The most publicized benefit of the Inflation Reduction Act is its effect on healthcare spending.

The law aims to lower insurance premiums by an average of $800 a year. The law also caps out-of-pocket spending for prescription drugs at $2,000 per year for Americans insured under Medicare, starting in 2025.

According to a survey, U.S. households in the bottom fifth of income cohorts pay an average of 34% of their income toward health care. Families in the highest income group pay 16% of their income toward health care.

For households in the middle, between 19.8% and 23.3% of their income goes toward health care, according to the study.

Considering that healthcare costs amount to over $12,500 per person (as of 2020), the Inflation Reduction Act may come as a reprieve for many Americans, especially those that have long-term health obligations. 

 

3. Energy

To fight climate change, the new law includes enticements for consumers to add energy-efficient upgrades to their homes.

Depending on your income, you can receive upfront discounts or tax rebates on home energy projects such as heat pumps, rooftop solar panels, or basic weatherization. All told, you may qualify for up to $10,000 in tax breaks and rebates, according to an analysis.

These incentives may also have a trickle-down effect on what you pay for utilities. Between home energy improvements and cheaper commodity prices, the average U.S. household could net roughly $170 to $220 in annual savings, according to an estimate from nonprofit research firm Resources for the Future.

 

4. Taxes

The most contentious part of the law is the taxes.

Its provisions include a 15% minimum tax rate on the adjusted financial statement income of corporations with an average annual adjusted financial statement income of $1,000,000,000.

The law also includes $3.1 billion to increase IRS taxpayer services, $45.7 billion for IRS enforcement, $25 billion for IRS operations support, and $4.7 billion for IRS technology upgrades.

The law extends and adjusts an existing tax credit on the purchase of “clean” vehicles such as electric cars, plug-in hybrids, and cars that run on hydrogen fuel cells.

The credit, worth up to $7,500 on the purchase of new vehicles, is available through 2032. You won’t qualify, however, if your income or the price of the vehicle you wish to purchase exceeds certain thresholds.

However, there is a growing assumption that the Inflation Reduction Act would see Americans pay more in taxes as seen from the amount of money being budgeted for the IRS and its operations. Also, analysts believe that companies would indirectly pass on parts of the minimum corporate tax to employees. 

According to calculations from the Joint Committee of Taxation, the law would lead to an increase of $16.7 billion for taxpayers earning less than $200,000 a year, $14.1 billion for taxpayers earning between $200,000 and $500,000, and $23.5 billion for taxpayers earning over $500,000)

 

5. Stocks

Just when investors were starting to regain their footing in what has so far been a volatile stock market this year, the Inflation Reduction Act may be forcing them to rethink which stocks to add to their portfolios.

The Inflation Reduction Act contains a 1% tax on stock buybacks and a 15% minimum tax for large companies that pay little or nothing in income taxes. That could hit big names like Amazon, Apple, and Tesla.

The buyback tax, combined with a new minimum 15% tax on corporations, is estimated to lower the 2023 earnings of S&P 500 companies by about only 1.5% per share. It will also create new costs that businesses will “now have to pass on to their customers.”

Theoretically, companies can respond to the proposed stock buyback tax in two ways: increase their dividends or stick to their buyback plans.

Companies that continue to engage in stock buybacks after the new tax is introduced in 2023 will see a reduction in profits as a slightly greater share of the profits would go to Uncle Sam.

If the 1% tax is significant enough for the company to issue dividends instead, investors could face taxes and likely see a lower tax return, rather than having the benefit of deferring those taxes to capital gains status when or if the investor ever sells the share.

 

 

Key Takeaways

The new Inflation Reduction Act aims to reduce the effects of inflation on Americans, but it appears this may be a lofty goal. For starters, it can reduce inflation in the short term, which is what most people need. 

Though the law gives tax credits and rebates for energy-efficient homes, consumers would have to spend a huge chunk of money to upgrade their homes to energy-efficient levels.

It also has implications for stock performance as companies may want to pass costs from the 15% minimum tax to consumers and 1% buyback tax to investors by way of dividends. 

The fact that many resources are allocated for the expansion of IRS activities raises eyebrows. The glimmer of hope however is in reduced healthcare costs by putting a cap on payments for prescription drugs. But this would not take effect until 2025. 

As such, despite the law, it appears that Americans would have to continue battling with rising living costs, which the only reprieve comes from the fact that headline inflation is showing signs of cooling off. However, inflation at 8.6% is way off the Fed's benchmark of 2%. 

Photo by Andrea Piacquadio

 

After falling behind the curve with its transitory message, the Fed Reserve has gone full throttle against rising inflation.

The latest CPI data pegs inflation at 8.6%, the highest level in 40 years. Prices of groceries, gas, housing, and transportation have gone through the roof. 

While consumers groan, the effects of the monetary policy are certain to inflict further pain in the pockets of many. The Fed Reserve Chairman, Jerome Powell, has scheduled more rate hikes this year. Observers expect those hikes to continue into the following year.

The Fed usually only raises rates by a small percentage (basis) points each time. However, those little drops cause dramatic moves across financial markets and asset classes. 

The effects of the last tranche of rate hikes are already causing ripple effects. The S&P 500 and NASDAQ have both dipped into bear market territory. 10-year Treasury yield has risen above the 3% mark, its highest since 2018. The US Dollar is having its longest streak of weekly losses in over 10 years.

If you’re planning on taking out a new home mortgage loan, credit card, or investing in stocks or cryptos, you may want to keep in mind that rates are higher now and this has affected not only allocation of capital, but investor sentiment also.

Knowing what to expect can assist you in determining what and when to invest. In this article, we examine how rising interest rates can affect money market accounts, equities, bonds, and commodities.

 

 

6 Ways Rising Interest Rates Affect Money Market Accounts, Equities, Bonds & Commodities

1. Money Market and CDs

If you’re in a high-interest non-investment account, you would be benefiting from rising interest rates without having to do anything.

As the Fed increases benchmark interest rates, banks and other financial services providers tend to increase the rates they offer on high-interest savings accounts, money market accounts, and certificates of deposit (CDs). 

Although these rates are still unlikely to match what you’d get from investing in the stock market long term, they can be a viable source of cash flow and asset protection. They can make these financial products a more attractive place to park your money.

If you’re already in a high-interest non-investment account, many banks will keep raising your rate without you having to do anything. If you’re not, this could be a good time to start looking around for an institution that’ll put more money in your pocket.

Should you already have money in a CD, rising rates won’t do much for you until the term ends, since you’re probably locked into what you signed up for. Alternatively, you can consider CD laddering to increase your income during this period.  

 

2. Bonds

When you purchase a bond, you loan money to a company or the government for a set amount of time and receive a fixed return in exchange.

When interest rates rise, bond yields—or the return you make on investing in a bond—rise as well.

Bond yields have been on the rise even before the Fed hiked interest rates. The 10-year Treasury note, which investors considered to be the barometer to gauge the bond market, is above 3%, its highest level since 2018.

 

3. Stocks

Unlike some investments, interest rates don’t have a single, defined impact on the stock market.

Rising interest rates have varied effects on stocks, depending on the sector that they are in. For high-growth multiple stocks whose price is based on future earnings, rising interest rates are bad news.

On the other hand, value stocks, especially dividend aristocrats, usually fare well during rising interest rates. Stocks in the financial, utility, and consumer staples sectors do well during this period of rate hikes.

But in general, a rise in interest rate is not good for stock markets. This is because stocks are a more risky asset class, compared to bonds where the return is guaranteed because it has the backing of the government.

As such, institutional investors prefer to allocate capital to areas where returns are guaranteed rather than investing in risky assets like stocks where you could get losses.

Similarly, because consumers are paying higher interest rates on existing bills, they have less money left over to spend on other goods and services. Reduced spending affects companies’ revenues and profits, which can have a ripple effect throughout the stock market. 

Companies also find it more expensive to borrow when interest rates rise. They may borrow less or have less money left over to invest in their business, or disburse as dividends to shareholders. This would also drive revenues lower, which would affect investor sentiment and price action towards the stock in a negative way. 

 

4. Commodities

Just like stocks, interest rates usually have an inverse relationship with commodities prices than they do to the stock market. When interest rates rise, commodities prices usually fall and vice versa. This is because of the cost of carry—the costs associated with holding inventory.

When interest rates rise, it is more expensive for the companies that buy commodities to stockpile them and store them for long periods. Likewise, when it's cheap to store inventory, businesses have more demand to stock up, which pushes costs higher.

As a result, companies will buy more commodities as they need them and lower demand will fuel lower prices.

 

5. Cryptocurrencies

Though the timeframe may be too short to formulate a thesis on how interest rates affect cryptocurrencies, the reaction of the crypto market can perhaps provide an inkling of what investors can expect.

Cryptocurrencies are regarded as a high-risk asset class. When rates are rising, investors tend to be risk-averse

As evidenced by current price action, higher interest rates take the shine off crypto investments, because they give savers the opportunity to secure more attractive returns in a lower-risk way. As such the prices of cryptocurrencies would decline until investors discover their appetite for risk (assets).

 

6. Currencies

Inflation tends to devalue a currency since inflation can be equated with a decrease in a money's buying power.

As a result, countries experiencing high inflation tend to also see their currencies weaken relative to other currencies.

However, because central banks exist to combat inflation, a rise in inflation leads to an increase in benchmark interest rates which inadvertently strengthens the currency. Currencies surrounded by lower interest rates are more likely to weaken over the longer term.

 

 

Key Takeaway on Rising Interest Rates

Rising interest rates affect assets in different ways.

As an investor, it is important that you have an understanding of how different investments react to rate hikes. This is the basis for knowing how best to deploy your capital and avoid, if not reduce, potential losses to your portfolio.

Being able to navigate market cycles is the hallmark of a successful investor. However, your success is anchored on an understanding of the unique characteristics of each asset and how to best trade them, and when. 

Photo by Enrique Hoyos