Interest Rates on the Verge of a Hike… Now What?

Meeting minutes from the Federal Reserve’s September meeting show that the team of monetary policymakers were more split than usual on whether or not to bump interest rates up. Most economists expected what eventually happened, that the Fed would maintain the current rates and look more earnestly at a change at their December meeting. Most experts expected the Fed to refrain from making any moves until after the November elections.

The last time the Fed made a move was last December. The fact that this vote had three advocates out of the ten members made market-watchers take note that there was more pressure to make a move than expected. That being the case, it would surprise few if the Fed increased interest rates next month. All indications show the economy is meeting the Fed’s target goals for employment – with unemployment figures hovering in the 5% range. Inflationary pressure is not quite at the target level, but, let’s just say the Fed seems to be trending toward wanting to make a move.

So, what does this mean?  Well, it depends.

If you’re a conservative saver, it means you may start to see the interest that you’ve been earning on your savings account or money market start to inch up. Those who have invested in bonds, on the other hand, will see the value of their bonds decrease as new bonds with higher rate returns provide a premium. In most cases, savers who have invested in stocks will likely see little immediate impact, as the stock market typically bakes in expected rate increases to market prices. However, over the longer term, higher interest rates can tend to slow growth of companies as borrowing costs become more expensive. This slower growth can lead to lower stock prices over time – but many other factors can affect stock prices as well.

If you’re in a prime spending period of your life, where you are looking to buy a car, a house or take out a loan for another big expenditure, or, if you just carry a lot of your expenses on credit cards, you can expect to pay a bit more, as interest rates for car loans, mortgages and home equity loans will increase.

Businesses also feel the effects of interest rate increases. Many borrow money to expand, buy new equipment or make other capital investments. Increased interest rates make this more expensive.

However, all of this comes with the caveat of future expectations. For example, if you were looking to buy a house next spring, you may be discouraged to take on the additional debt at a higher cost if interest rates increased. However, if you were planning to buy a house, but you expected several interest rate increases in 2017, you may consider responding by making your purchase before these rates increase – so you could make your purchase at a relatively lower rate than what it would cost say, a year from now.  In the case of an expected series of increases, the Fed could actually be unintentionally (or not) encouraging purchases to be made sooner rather than later, creating a short-term spike in economic activity.

So, what should we expect?  In the past, the Fed has historically indicated the expectation that they would increase interest rates at a faster pace than what they did in reality.  If that continues to be the case, expect rates to gradually climb over time, making it fairly predictable for the markets to anticipate. And as we all know, the market likes things that are predictable.

Sources: 

http://www.bankrate.com/financing/federal-reserve/the-feds-close-call-on-interest-rates/
http://www.investopedia.com/articles/06/interestaffectsmarket.asp
http://fortune.com/2015/12/16/feds-rate-hit-you/

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