The highly anticipated rate increase by the Federal Reserve today and its first in nearly a decade, exhibits faith by the central bank that the U.S. economy is demonstrating signs of improvement. The Fed decided to increase rates by 25 basis points.
“The Fed’s decision to raise rates is because the economy is getting better,” said Greg McBride, chief financial analyst for Bankrate, the North Palm Beach, Fla. based financial content company. “A better economy is good news for corporate profits and stock prices.”
Since the last rate increase occurred back in 2006, consumers have benefited from cheaper borrowing options with record low mortgage rates and 0% credit card offers.
The first increase is nominal, but consumers should consider the cumulative effect of the Fed increasing rates periodically over a span of two to three years, especially with variable rate loans. The consecutive rate hikes will affect homeowners with an adjustable rate mortgage when it resets, which typically happens once a year.
“If the Fed raises interest rates two to three times, the next adjustment after that could be a steep payment increase for consumers,” McBride said. “Right now fixed 30-year mortgage rates are 4.0%, so get out of your current adjustable rate mortgage, refinance into a fixed rate and insulate yourself from rising rates.”
The 0.25% rate increase equals to a payment of $0.25 for every $100 in debt you owe. The seemingly token increase adds up quickly for credit card payments and home equity lines of credit and will be reflected within one to two payment statements, McBride said.
Credit card interest rate increases mirror the Fed's increase, and issuers will raise rates by 0.25%, McBride added. The 0% interest rate offers will not last long and are a “great window of opportunity to get your debt paid off," he said.
“As the Fed moves away 0%, the credit card companies will be less generous and the rates will rise while the period of no interest rates will shrink from 18 months to 12 months or even six months,” McBride said. “The offers will not be as good a year from now.”
Savings and Retirement Portfolios
Interest rates for savings accounts and CDs will not rise in the near term, because banks are “already flush with deposits and do not need to raise rates,” he said. “Savers waiting for the improvement to come to them will be disappointed and will have to find top yields online at community banks and credit unions, which are already paying the most competitive returns and will most likely stay that way.”
The stock market will continue to experience periods of extreme volatility, but investors need to “grit their teeth and deal with it for awhile,” McBride said. “Volatility is par for the course. Some of it maybe unnerving and there will be significant swings in the market. Keep focus on your long-term objectives and resist knee jerk reactions in order to have long- term financial security.”
Effect of Delay
The delay in the Fed's raising interest rates has impacted the stock market, resulting in “unnecessary” market volatility that has led to lower returns in retirement plans, said C.J. Brott, founder of Capital Ideas, a registered investment adviser in Dallas and a portfolio manager with Covestor, the online investing marketplace.
“I did not think they would raise rates this year,” he said. “Purely on a fundamental basis, they missed the window and should leave things alone until Europe catches up with the U.S. and the Chinese exchange rates settle out. The world’s central banks would be acting in concert and volatility in foreign exchange markets would be less, along with the impact on debt and equity markets."
The inaction of the Fed has benefitted consumers who could take advantage of the zero interest rate environment and pay less money toward interest costs while a large amount of liquidity was also injected into the financial system and “buoyed the equity markets,” boosting returns on retirement portfolios which concentrated in stocks, said Robert Johnson, president of The American College of Financial Services in Bryn Mawr, Pa.
“Individuals who hold stocks in their retirement portfolios have benefited from low interest rates and the so-called ‘great rotation’ where money went from the bond market to the stock market,” he said. “As rates rise in the future, you could see the great rotation reversing itself as investors exit the equity markets and return to the bond markets.”
Future Fed Actions
The Fed will continue to raise rates several times next year, since today’s move is not a “one and done” move, said Johnson. If the economy continues to show signs of recovery, the Fed will likely follow with a series of three to four rate increases in 2016, raising interest rates to a total of over 1.0%, which will cause mortgage rates, auto loans and credit card rates to rise in concert.
Returns generated from the stock market will be “be difficult” over the next several years because of the long bull market, said Don Shelly, a professor of practice in finance at Southern Methodist University’s Cox School of Business in Dallas.
The market has been flat this year despite periods of intense volatility, yet the S&P 500 averaged a return of 20% per year from 2009 to 2014. The six-year bull market helped investors who lost money during the financial crisis, but long bull markets create complacency, leaving investors with an “'I’ll know when to get out before the next bear market' mentality," Shelly said.
“The stock market is expensive by most historical measures, but if bonds begin to become a more reasonable risk for return substitution for stocks, this isn’t good for the market,” Shelly said.
Riskier assets will become less attractive and more volatile as investors will be drawn even more to safer assets, said Patrick Morris, CEO of New York-based HAGIN Investment Management.
“This cycle has been very tough on savers,” he said. “The good news is that consumers are comfortable making zero percent on savings and paying 29.99% on credit, so I don't see any immediate changes in buying behavior.”