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Fed Rate Hike Is A Double-Edged Sword… Make The Most Of It!

Steve Pomeranz, Fed Rate Hike

Third Fed Rate Hike In 2018

On September 26 (2018), the Federal Reserve raised interest rates for the third time this year to a target range of 2 to 2.25%, basing the move on a strong economy, solid job gains, and low unemployment. In addition, the Fed noted that inflation remained near 2 percent—which is their magic number.

Expect Steady Rate Hikes Going Into 2019

In its statement, the Fed said it will continue to raise interest rates as long as these conditions continue.  The conditions they’re referring to are that for the first time since 2008, the U.S. economy is no longer fragile and our economy is on solid footing able to withstand further rate hikes without crimping economic growth.  This is a powerful statement and not one which should be taken lightly. I think we can all break out the champagne now.

So, I think we can expect one more hike before the end of 2018 and maybe at least three more 1/4 point hikes in 2019.  The simple math suggests, therefore, that the Fed funds rate could be in the 3 percent to 3.25 percent range or higher by the end of 2019.

It’s this implication that drives my commentary today.

Implications Of A Fed Rate Hike

What does this kind of rise in rates mean for the broader economy—and for all of us individually as investors, savers, and consumers?

For one, any increase in interest rates has an immediate ripple effect on all manner of financial assets. For example, borrowers have already seen interest rates rise for home mortgages, home equity loans, credit cards, student loans, and more.

In the investing arena, interest rate increases have caused some uncertainty on both domestic and foreign stock markets. We might continue to see more volatility until the market can digest whether indeed the Fed is right in its assumption that the U.S. economy can withstand these higher costs.

However, if you’re a saver who puts his money in Certificates of Deposit, money markets, and bonds, you will see more money in your pocket. It’s been a long time and the drought is finally over.

Major Rate Increases

Let’s put things in perspective.  Since the Fed rate hikes began a few years ago, the interest charged on average credit card rates have jumped from 15.78 percent to 17.32 percent.  Rates have also increased on home equity loans from 4.75 percent to 6.08 percent.

Adjustable rate mortgages are expected to jump to 5.25 percent or more.  By the way, if, perchance, you have an adjustable rate mortgage, now may be a good time to convert this into a fixed-rate mortgage.

With everything interest rate related in flux right now, a recent AP article on Yahoo! Finance, broke down the impact of interest rates on various age groups. As a Financial Planner, this got my attention because thinking of it in this light could help people of all ages see what the direct effect may be on their personal financial situation.

Here’s my summary of the AP article: First, independent of age, let’s be clear that credit card rates will probably be the first to go up since the rise in credit card interest rates almost directly matches the rise in the Fed funds rate.

These Fed rate hikes are expected to increase credit card interest by about $150 per year for the approximately 122 million Americans who carry credit card debt.  And—listen closely—this expense will only rise as rates continue to climb.

As I always say, credit card debt is typically your highest interest-bearing debt, so it’s best to pay this down to zero as soon as you can…now more than ever in today’s rising interest rate environment.

Impact On 20+ Age Group

The impact on the 20+ age group is mostly related to the cost of student loans. As college tuition rises year after year, you may be surprised to learn that college financing costs are rising at an even higher pace in percentage terms.

Student loans are tied to rates on the 10-year Treasury bond and virtually every Fed rate hike ripples through to the 10-year rate.  Accordingly, the rate on student loans is 5.05 percent in 2018, up from 4.45 percent in the prior school year.  While that 0.60 percent increase may not seem like much, the rate is now 13.5 percent higher than last year!  Beware… these things have a way of piling on and getting out of hand. You want to get out in front of this if you can.

For The 30 To 40 Age Group

People in their 30s and 40s typically have young families, perhaps with a single income as one spouse stays home to raise the kids. There are also mortgages, car loans, and student loans to name a few life needs that are filled by borrowing money during these years.

Of these loans, I want you to quickly pay off those with floating interest rates before rates rise even higher. Floating loans typically include credit cards, home equity loans, and student loans from private lenders.

If you’ve already bought a home and acquired a fixed mortgage, you, like me, are lucky to have locked in a low rate.  If you’re still planning on buying a house, expect rates to go up in the coming months and years.  In fact, these impending rate increases I have been speaking about are driving the sales of starter homes, with millennials eager to take advantage of still-low mortgage rates.

As an aside, mortgage rates are typically 15- and 30-year rates.  Because they are longer term, these rates do not move in lockstep with Fed rate hikes.  So, although the Fed has increased rates by about 2 percent, the 30-year mortgage rate has only risen by 0.7 percent, from 3.9 to 4.6 percent.  So, if you still haven’t bought, don’t panic! Mortgage rates will inch up in 2019, and I don’t expect them to shoot up a lot higher too quickly.

50+ Age Group

If you’re on the savings side of life, rejoice! Rates are moving higher, albeit at a snail’s pace.

In general, rates on 12-month CDs have crawled up to about 0.45 percent on average.  The rate on a 5-year CD is about 1.11 percent, up from 0.87 percent a year ago.  So, the increase hasn’t been all that exciting. I do expect savings rates to accelerate higher and faster. Once banks weigh the cost of earning more profit from not paying you more right now against the risk of losing deposits to aggressive competitors, they will come to realize that they will need to raise rates more aggressively. So, let their games begin! This is the fun part seeing these institutions duke it out.  Remember, they are fighting for our dollars; so, at least, for the foreseeable future, we are in the driver’s seat.

One caveat: I am not a big fan of investing too much of your money in these types of vehicles because, after taxes, you’re losing out to inflation.  This means that when you do the final tally, your cost of living is rising faster than your money’s ability to keep pace. This may end up hurting you in future years to come.

This aside, shop for the highest “safe return” you can get. And don’t be afraid of online banks. Online banks are generally quicker to raise rates on CDs and savings accounts than local brick-and-mortar banks, so shop around online to see who’s willing to give you more on your money.

What’s My Final Take On This Subject?

Boiling it down in a nutshell, a Fed rate hike is a double-edged sword. If you’re a spender who borrows to fund your consumption, higher rates will hurt you, so it’s time to get defensive in a rising rate environment and cut down on your floating rate loans.

If you’re a saver, you should be slightly better off with higher rates, but I’d still caution you against putting too much of your money into something that underperforms inflation.

And finally, if rates go much higher, quicker than expected, it will most likely negatively affect stock prices. While I don’t see this happening right now, it is something to keep an eye on.

Also, remember that for long-term investors, I’m talking 10 years or more. Stocks have been a superior place to be in almost all long-term time periods.

To balance out these pros and cons, make sure you spend some time talking to your financial advisor about how this new rising rate environment will affect your money, for good and bad, and make sure they’re analyzing and soundly counseling you on your specific needs.

This commentary contains the author’s personal opinions which are not necessarily the opinions of United Capital Financial Advisers, LLC (“United Capital”). Certain statements contained within are forward-looking statements including, but not limited to, predictions or indications of future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties. Opinions expressed are current as of the date of this publication and are subject to change. United Capital provides financial life management and makes recommendations based on the specific needs and circumstances of each client. For clients with managed accounts, United Capital has discretionary authority over investment decisions. Investing involves risk and clients should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. The information contained in this commentary is intended for information only, is not a recommendation to buy or sell any securities, and should not be considered investment advice. Please contact your financial adviser with questions about your specific needs and circumstances.

I've been an investment strategist and adviser for over 35 years, leading with a mission of unbiased advice to educate and protect listeners on my weekly radio show on NPR affiliates nationwide. I have been named a “Top 100 Wealth Advisor” by Worth Magazine and “Top Advisor” by Reuters.