How Will A Fed Rate Hike Affect You?

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The Federal Reserve Bank will conclude their regular meeting today and when they do they will release a statement. That statement will be a summary of their conclusions about the state of and prospects for the economy and announce any changes to short-term interest rates.

Often, when that happens there is some doubt about what will happen to rates, but not this time. The market is almost unanimous in the belief that today will see another in a series of small rate increases, so the focus of traders and investors will be on what the Fed says about the prospects for the economy and what hints are given about future hikes.

Essentially though, that is just another guess. It is an informed guess, for sure, but as smart as the Federal Open Market Committee (FOMC) members are, they are still working with the available data, not a crystal ball. Economic problems and market corrections tend to come from unforeseen problems and, by definition, the Fed doesn’t have a stellar record of seeing those things coming.

So, while predicting the future can be fun, what matters to most investors are the immediate effects of a rate hike on them. Those effects will be felt in three main areas, loans, savings, and investments.

Loans: Most of us have loans of some kind, usually mortgages, car loans, and or credit card debt. The Fed doesn’t control those things directly, but their decision today will still affect what people pay on that kind of personal debt, either now or in the future. Most mortgages are at a fixed rate, so there will be no immediate effect for those with those loans.

When you move or reschedule your mortgage for some other reason though, future loans will be more expensive. If you have an Adjustable Rate Mortgage (ARM) without a period of fixed interest, you will pay more immediately.

Car loans will be similarly affected. Your current loan is almost certainly at a fixed rate, so payments won’t change, but future car financing will be more expensive. Credit card rates will probably increase immediately. Because minimum payments are calculated as a percentage of the outstanding balance that may not mean higher payments immediately if you make only minimum payments, but the balance will take longer to pay off.

Savings: For those with little or no debt and substantial cash savings, the expected hike will be good news. For nearly a decade, those who have taken a more cautious approach to their personal finances have been punished. Money market accounts, savings accounts, CDs and other cash savings vehicles have been paying almost nothing since the Fed cut rates to effectively zero in response to the recession of 2008/9.

That may seem unfair, but it was quite deliberate. The Fed’s intention was to encourage borrowing and investment to get the economy moving again and rewarding both borrowing and risk-taking was the best way to do that. The flip side of that coin was that savers have suffered, but as short-term rates move up a more normal return on savings will result.

Investments: For most investors, there are two types of investments, stocks and bonds.

From the perspective of stock investors, the effects of today’s announcement are less predictable and not as straightforward as economic theory suggests. Logically, it should follow that if future borrowing (and therefore spending) will be disincentivized by a rate hike and saving will be encouraged, higher interest rates should have a dampening effect on economic growth. That, in turn, should therefore have a negative impact on stock prices.

This time around though, two factors combine to make a positive reaction in the stock market to a rate hike possible.

The first is that everybody is expecting a hike, so the effects are already priced into the market. The second is that the Fed feels that higher rates are justified due to economic strength. I said above that the Fed’s view on the future of the economy was just another guess, but it is the most influential guess there is.

If some of the smartest minds in the country, with access to all the data, conclude that the economy is strong, the stock market will see that as a positive. It is quite possible that there will be a knee-jerk downward reaction to a hike, but prices will likely quickly recover and enter another sustained strong period.

The outlook for bond investors is not as positive. Interest rates and bond prices are inversely correlated, meaning that if rates go up, prices go down. The value of bond investments will therefore decline as rates rise. Once again, this hike is priced into the market to a large degree, so the effect will be a little muted, but even so it is likely that yields will move a bit higher and bond prices will fall.

There is no escaping the effects of today’s Fed decision. Most of us have loans, savings and investments of some kind. Even if you rent, carry no car or credit card debt, and don’t have a stock account you probably have exposure to both stocks and bonds if you have a 401K through your job or any other kind of retirement savings.

There will be plenty of other things vying for your attention today, the Kavanaugh hearings in the Senate not least among them, but we should all be paying attention to the Fed this afternoon.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Martin Tillier

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