The Fed is expected to make a move soon; what will the impact be?
by Phil Britt
The Federal Reserve is expected by many economic experts to hike interest rates as soon as September and perhaps again in December.
The Fed took a pass on increasing the Federal funds rate at its June meeting, with Federal Reserve Chairwoman Janet Yellen saying the board needed further improvement in the economy before making the move. When the Fed does increase rates, be it September, December or, if the economy unexpectedly weakens in 2015, sometime in 2016, it will mark the first increase since 2006.
The rising interest rates will affect the finances of most people, primarily on the things that they buy on credit as well as their investments.
We asked Bill Witte, associate professor emeritus of economics, who continues to conduct research for the Center for Econometric Model Research in the IU Kelley School's Indiana Business Research Center, to discuss how he sees rising interest rates affecting different loans and investments.
Here's a look at some of the effects of rising interest rates:
Home loans–Fixed-rate loans with rates already locked in will look even better as rates trend up with what the Fed does. It's not an exact science, a one-quarter point interest rate increase by the Fed does not automatically lead to a one-quarter interest rate increase in new fixed home loans–the fixed-rate loans are more closely tied to the rates on 10-year bonds, which have already trended up–Witte points out. The best home rates for a 30-year mortgage were right around 4 percent in mid-June, up from 3.25 percent a year earlier. If the Fed bumps rates up, the fixed-rate loans will likely continue to rise, though not necessarily as much as the Fed increases.
Adjustable-rate loans, on the other hand, could see an increase that mirrors or even exceeds the Fed's moves, Witte says. Those who already have adjustable-rate loans could see a larger than expected rise in rates–and in payments–when their loans readjust from initial teaser rates.
The good news for home sellers is that the Fed finally pulling the trigger on higher interest rates will likely push some potential buyers into the market in order to lock in rates before they go yet higher. However, the weak home sales still have to overcome other economic issues, including Millennials who are more reluctant to buy homes than their parents were at the same age, the continuing overhang from the housing bust and relatively weak wage increases over the last several years.
Personal loans–Loans for automobiles, home equity, etc., will be affected more than fixed-rate loans, but less than adjustable-rate loans, according to Witte.
Credit cards–Even though credit card rates are well into double digits already, the rising interest rates will mean that those rates will go up along the lines of personal loan rates. So it will be more expensive than it has been for years not to pay off balances each month. Credit card issuers will likely be less generous with their zero percent promotional offers as well.
Stocks–Stock prices are expected to go down, initially, with utilities and other interest-sensitive stocks hit the hardest once rates start rising. People tend to buy utilities and other large dividend stocks primarily for the yield, Witte explains. But the dividends won't go up with the Fed's move, so the yields will no longer look that attractive.
The picture isn't as clear with growth stocks, Witte says. Many of these stocks could go down in anticipation of the Fed's move, then trend back up once the announcement is made because uncertainty will be removed. The big issue, according to Witte, is whether any Fed action has a negative effect on the overall economy. If it does, then stocks on the whole will trend down. However, the Fed theoretically wouldn't be increasing rates if the Fed governors didn't think the economy was strong enough to support more normal rates–historically around 3 percent, not the current 0.25 percent.
Yellen emphasized during her remarks in June that the Fed's moves would be data dependent. If that theory holds and an increase does seem to put too much slack in the economy, the Fed would keep the lid on future increases. So any stock market effects of moves or non-moves could be dramatic, but short in duration.
Bonds–Bonds will drop in price with the rise in rates, but the good news for investors is that new bonds will offer higher yields because bond issuers will now need to pay more to attract investors to purchase the obligations. Yet bond prices will continue to trend down until rates stop going up, Witte says. So unless an investor plans to hold a bond to maturity, he or she is better waiting to purchase bonds for another two to four years–when any Fed rate increases are expected to be over, according to Witte.
