Economists Mull Impacts as Fed Nears Possible Rate Hike

As the Federal Reserve mulls a possible rate increase, economists say the change could have disparate effects in different parts of the economy.

Interest rates.

The 2 words bring to mind concerns relevant to any investor, but especially individuals with savings accounts, money market holdings, mortgages, loans, stocks, and bonds.

Borrowing costs, after all, are what influences a lot of investment decisions. The meetings by the country’s monetary policy makers, like the Federal Open Market Committee gathering held in mid-March, are typically analyzed by bankers, economists, financial advisors, and traders, and it’s hardly a wonder.

For the average individual, the statements Central Bank officials make are akin to deciphering Egyptian or Mayan hieroglyphics, or as Brenda Wenning, who runs Newton, MA-based financial advisory firm Wenning Investments LLC, noted in her recent assessment of the March Federal Reserve (Fed) meeting: “Many brain cells seem to die in the reading and interpretation of policy statements of the Federal Open Market Committee.”

At the core of the most recent Fed meeting was discussion of raising the country’s interest rate target of 0% to 0.25% amid an improving job market and sluggish inflationary environment, possibly sometime around the summer. “Economists, strategists and even some non-voting Fed board members are vocalizing that there’s going to be a lift off sometime this year,” said Wenning.

Market talk had swirled about a potential increase taking place as early as the summer, but as a US Fed official pointed out in a recent article published on Physician’s Money Digest, with core inflation still below 2%, an increase in the next few months isn’t likely.

Any increase would be welcome news for consumers with traditional savings accounts, low yielding money market accounts, or CDs. It’s a different story for well-heeled corporate borrowers that have taken advantage of historically low interest rates to arrange billions of dollars of loans to finance their strategic growth plans as smaller businesses have watched borrowing their costs rise against the backdrop of tighter lending standards on the part of banks.

Before tackling what an interest rate uptick might mean for consumers, it’s worth noting that the Labor Department reported its Consumer Price Index (CPI) increased 0.2% last month after declining 0.7% in January, a reversal from 3 straight months of declines.

Furthermore, as Fed chair Janet Yellen outlined in her remarks last month before the Senate Committee on Banking, Housing, and Urban Affairs, employment prospects are brightening (295,000 jobs were added in February). The unemployment rate sits at 5.5%, according to Labor Department data.

So, back to the question of what a change in the Federal Funds rate — the overnight interest at which banks borrow from each other – would mean for the average investor. With an increase on the horizon, Wenning said prospective homebuyers would do well to consider moving forward on home buying. “For anyone in the market wanting to buy a house, you may want to do it before June,” she added.

Mortgage rates have dipped of late. The 30-year fixed mortgage slipped to 3.8% from 3.91% last week, whereas the 15-year fixed mortgage fell to 3.04% from 3.15% last week, according to Bankrate.com’s latest lender survey.

For investors that favor bonds over stocks, an interest bump dictates consideration on investing in short-term instruments to offset a potential downturn that would impact longer-term bonds.

“A 100 basis point, or 1% move up in rates, would cause a 10-year bond to decline anywhere from 8% to 10% in value. The shorter the maturity, the less price fluctuation you will see,” Wenning said.

Similarly, a rise in interest could impact equity investors, causing stock prices to fall as investors pull back from the market. On a related note, when it comes to one of the more common products to emerge in the last decade — exchanged traded funds or ETFs – Wenning advised that if rates move higher a 1-to 3-year treasury ETF would help protect principal.