It’s official. The Federal Reserve just raised interest rates by 25 basis points, or one-quarter of a percentage point.
The move boosts the short-term federal funds rate to a range of 0.5% to 0.75% from the previous 0.25% to 0.5%.
It was the first increase since last December, and the second of the overall rate-hiking cycle.
So what does this move mean to you and your finances? Here are five important consequences …
- Floating-rate fund rates will rise. Remember floating-rate funds? I wrote about them in my last issue Fighting Back as Rates Rise: Four Investment Strategies for You. These are ETFs and mutual funds that own corporate bonds whose coupon payments adjust higher when benchmark short-term rates rise.
They haven’t yielded much thanks to years of rock-bottom rates. But with two rate increases in the bag now, and more likely coming down the pike, those yields are going to climb. That makes them a solid investment for any funds you have dedicated to the fixed income (bond) universe.
- Variable rate loans will get more expensive. It’s time to dust off the paperwork you got when you took out that Home Equity Line of Credit (HELOC), or when you opened that last variable-rate credit card. Chances are the interest rate you’re charged is linked to the prime rate … and the prime rate moves in lockstep with the fed funds rate.
Translation: Within the next few days or weeks, your interest rate will rise. That means you’ll pay more in interest charges on any outstanding balances.
If you have an Adjustable Rate Mortgage (ARM), your home loan rate may be tied to a different benchmark rate. One of the most common is the London Interbank Offered Rate, or LIBOR. That rate also tends to fluctuate along with the funds rate. So when you hit your next annual adjustment date, you can expect to see your rate and required monthly payment climb.
- Savings accounts and CDs will get more rewarding. On the flip side, if you’re a big saver (rather than debtor), you’re in luck. The yields banks offer on Certificates of Deposit will rise, as will the paltry yields paid on Money Market Accounts and other savings accounts.
Indeed, the national average rate on CDs has already started rising by a few basis points in anticipation of a Fed hike, according to Bankrate.com’s rate-tracking tool. You can graph trends for different products and time frames online here http://www.bankrate.com/funnel/graph/
- Some Stocks Will Rise Along with Rates, While Some Will Fall. Rising interest rates are generally bullish for bank stocks, because they help fatten the profit margin banks earn from making loans. On the flip side, rising rates are generally bearish for Real Estate Investment Trusts (REITs), utilities, Master Limited Partnership (MLPs), and other “bond-like” stocks.
But that’s a very general rule of thumb. A lot depends on whether or not long-term rates follow short-term rates higher. Which brings me to point number five …
- The Impact on Long-Term Bonds Depends on What Signals the Fed Sends Out. You might think that a Fed rate hike is pure poison for longer-term bonds or funds that invest in them. But this is where things get tricky.
The Fed only directly controls the very short-term funds rate. Its sway over the bond market is much more indirect. Indeed, it’s the “buy” and “sell” decisions made by big bond investors that truly matter. And the biggest driver behind the decisions these so-called “Bond Vigilantes” make is future inflation risk.
Let’s say that the Fed hikes rates, then the Fed Chairman uses her post-meeting press conference to signal they’re going to be very aggressive with future rate increases to keep inflation from getting out of control.
That would lead bond investors to conclude: “A-ha! The Fed is going to raise rates a lot NOW to keep inflation from getting out of control LATER!”
As a result, the vigilantes would actually start buying bonds on Fed day. Since bond yields move in the opposite direction of bond prices, that means long-term rates could actually fall even as short-term rates rise.
Alternatively, let’s say the Fed takes the timid approach. In other words, the Fed Chairman signals in her comments that policymakers will be very slow and gradual with future hikes.
That would lead bond investors to worry about future inflation, prompting them to dump bonds. That, in turn, would mean long-term rates will rise alongside short-term rates.
Confused yet? I sure hope not! But even if so, don’t worry. I’ve spent my entire two-decade career closely following and analyzing the interest rate market. In fact, it’s my specialty here at the Weiss organization.
So you can have the utmost confidence that I’ll be right by your side during this rate-hiking cycle — explaining WHY the Fed is hiking, WHAT those moves mean, and HOW you can profit from them. Keep your eyes peeled for more details on that in early 2017.
Until next time,
Mike Larson is a Senior Analyst for Weiss Research, and is also the creator of the course “How to Profit From Rising Interest Rates”. A graduate of Boston University, Mike Larson formerly worked at Bankrate.com and Bloomberg News, and is regularly featured on CNBC, CNN, Fox Business News and Bloomberg Television as well as many national radio programs. Due to the astonishing accuracy of his forecasts and warnings, Mike Larson is often quoted by the Washington Post, Chicago Tribune, Associated Press, Reuters, CNNMoney and many others.