The Federal Reserve will likely raise short-term interest rates this week, when it convenes the last policy meeting of 2016. The second rate hike of the cycle comes one full year after the first, nine years after the last time it had previously raised rates. The central bank is probably more confident about this action than it was a year ago, because it will occur after the President-elect indicated that there would likely be a new boost to the economy, in the form infrastructure spending, tax cuts and deregulation. While GDP averaged a fairly subdued 2 to 2.25 percent during the recovery thus far, the potential Trump actions have prompted economists to increase their estimates for 2017 to 2.5 to 3 percent. Economists and investors will be paying close attention to any mention of how the FOMC may change its outlook in response to the major fiscal stimulus that will likely be enacted. A faster growing economy could mean that the Federal Reserve will finally see its much-desired pick up prices and as a result, the central bank should be gearing up for a series of rate hikes in 2017.
Here’s the rub: for all of candidate Trump’s complaining about Janet Yellen’s Fed keeping rates too low for too long, the biggest risk to the current expansion would be if the Fed were to move more quickly than anticipated, putting the current stock market rally at risk and potentially sparking a recession.
Fear not…current Fed officials appear to on track to under-deliver on their inflation target, as they have done consistently over the past twenty years. That’s why Yellen has been so willing to be patient on raising rates. Although Trump took aim at Yellen for not raising rates faster, she may in fact be the ideal Fed Chair to keep the economic expansion/stock market rally alive in 2017.
HOW WILL THE FED’S ACTIONS IMPACT CONSUMERS?
Savings: Any increase in the Fed Funds rate could help nudge up rates on savings accounts, but after the first increase, banks passed very little of the increase on to their customers. Bottom line: savers’ suffering is not likely to end any time soon.
Mortgages: While rates for fixed rate mortgages key off the 10-year government bond, not short term rates that the Fed controls, yields have already started to rise since the election. The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($417,000 or less) increased to 4.27 percent, the highest level since October 2014 and up from 3.5 percent before the election. Adjustable rate mortgages (ARMs) are linked to shorter-term rates, which means that consumers should be careful about assuming these loans and also should consider locking in a fixed rate now. Those who have ARMs could see payment increases down the road.
Auto Loans: For those planning on purchasing a new car with a loan, don’t worry too much. An extra quarter-point increase on a $25,000 loan amounts to a few dollars a month in higher payments.
Credit Cards: Most credit cards have variable rates and unlike the savers, the card companies are quick to pass along the increase to the borrowers within a few billing cycles. You may want to consider locking in a zero balance transfer offer, because it won’t be around as the Fed keeps increasing rates in 2017.
Student Loans: Federal loans are fixed, so there will be no impact from a rate increase, but some private loans are variable. Double check your paperwork to determine what benchmark rate (Libor, prime, T-bill) your loan is tied to.
HOW WILL THE FED’S ACTIONS IMPACT INVESTORS?
Stocks: If the Fed goes slowly and the economy improves, the stock market should be fine. But, as noted above, if the central bank ends up raising rates faster than expected, it could hurt prices. In the past, shares of banks, energy, industrials and technology do well amid rising rates.
Bonds: When interest rates rise, bond prices fall and in this particular cycle, it could be even more painful, because the slow growth recovery lulled many bond investors into complacency. That said, there is no reason to abandon the asset class. For most investors who own individual bonds, they will hold on until the bonds mature and then purchase new issues at cheaper prices/higher rates. For those who own bond mutual funds, they will reinvest dividends at lower prices and as the bonds in the portfolio mature, the managers will reinvest in new, cheaper issues with higher interest rates. In other words, being a long term investor should help you weather rising interest rates, though you may want to consider lowering your duration, using corporate bonds and keeping extra cash on hand. (For more on bonds, check out this post.)
MARKETS: There were new records all around, providing more post-election gains. Since November 8th, the Dow is up 8 percent, the S&P 500 has gained 11 percent and the NASDAQ is up 9 percent.
- DJIA: 19,756, up 3.1% on week, up 13.4% YTD (23rd record close of 2016)
- S&P 500: 2259, up 3% on week, up 10.6% YTD
- NASDAQ: 5444, up 3.6% on week, up 8.7% YTD
- Russell 2000: 1388, up 5.6% on week, up 22.2% YTD
- 10-Year Treasury yield: 2.47% (from 2.39% week ago)
- January Crude: $51.48
- February Gold: $1,161.40, 5th straight weekly decline
- AAA Nat'l avg. for gallon of reg. gas: $2.20 (from $2.17 wk ago, $2.01 a year ago)
THE WEEK AHEAD:
6:00 Small Business Optimism
8:30 Retail Sales
9:15 Industrial Production
2:00 FOMC Meeting Announcement/Economic Forecasts
2:30 PM: Fed Chair Janet Yellen press conference
8:30 Empire State manufacturing survey
8:30 Philly Fed manufacturing survey
10:00 NAHB homebuilder survey
8:30 Housing Starts