When the Federal Reserve meets December 13-14, we expect them to raise interest rates one quarter point (0.25%).
Many economists feel the rate hike is long overdue. By raising rates, the Fed can show confidence in improving U.S. economic conditions and a strengthening economy.
Here’s some key points to keep in mind regarding a potential rate hike:
There’s nothing to fear. The hike will likely be a small one (0.25%), which will boost rates to a target range of 0.5% to 0.75%. It’s a sign that the U.S. economy is on the mend.
Back to normal. After years of abnormally low interest rates, the Fed wants to “normalize” by bringing rates back into positive territory. Holding rates low for so long has risked damaging the economy. “Historically low interest rates and massive bond purchases punished savers and rewarded risk-taking behavior, increasing the odds of financial market bubbles and other imbalances, including inflation,” say economists at investment management firm American Century.
Winners and losers. Savers will be the big winners as rates nudge upward. For far too long, retirees and other cautious savers have earned virtually nothing on their nest eggs. Who loses? Americans with credit card, student loan, home equity or other consumer debt may see their monthly payments move up. Ditto for home buyers shopping for a mortgage.
A hint of inflation? Inflation has been DOA for years, but rising prices may become a new reality. The job market is tightening, wages are starting to trend upward, and President-elect Trump promises to step on the pro-growth gas pedal. It’s time for investors to stand guard on “inflation watch” and stock their portfolios with assets that can keep up with growing prices, like equities, real estate, inflation-protected and floating-rate bonds, and natural resources.
The end of an era. Hard to believe, but interest rates have headed steadily downward for almost forty years (see the long-term chart here). Now, they might be trending gradually up. That portends a more challenging era for stocks, bonds and other investment assets. How will this affect you? Expect moderate investment returns (higher interest rates could be a headwind) and plan on setting aside more savings to cover your needs.
What’s ahead? No one knows. Since the elections, the investment markets have been turned upside down. Investors have loaded up on stocks and tossed their bonds overboard, based on what they think will happen with a Trump presidency. Before you start chasing the trend, remind yourself that the investment masses are usually wrong. Follow them at your peril. So while rates are undoubtedly headed up, we can’t predict how far or how fast they’ll move.