The Federal Reserve recently announced on December 16 that it would increase the Federal Funds rates by 0.25%. It has been 3,457 days since the Fed increased rates, with the last rate increase in 2006, or almost 9.5 years. The Fed’s policy of ultra low rates was initiated during the Great Recession and was intended to help stimulate an economy that was reeling from the sub-prime mortgage crisi. Evidently, the Fed believes that the economy is strong enough to withstand a return to a more normal rate environment.
Most observers believe that the Federal Reserve will continue to raise rates through 2016 and 2017. Some believe that the Fed will increase rates three or four times in 2016. According to Brian Wesbury, Chief Economist at First Trust, on December 17, the federal funds future market is priced to anticipate two rate hikes next year.
Here is a guide to what it means for the rest of us:
Mortgage borrowers may consider that now may be the time to refinance , especially if you are on an Adjustable Rate Mortgage (ARM). The December 16 increase is not likely to have a very strong impact on long term interest rates, which tend to follow the 10 year Treasury rate. However future fed funds rate increases will most likely push the yield curve up, leading to more costly refinancing down the road.
the very modest increase in the Fed Funds rate will not yet trigger an increase in bank and CD rates sufficient to cause a stampede from mattresses to CDs
On the other hand, short term mortgage rates will be affected immediately thus leading to an immediate increase in ARM payments. As noted above, conventional wisdom is that rates will continue to increase , and will eventually have a substantial upward impact on traditional long term mortgage rates. Get yours while you can!
Borrowers with Home Equity Lines of Credit (HELOC) will be impacted directly by the fed funds increase with increased monthly payments which will become more painful as the Fed continues to step up rates over the next few years. If you have the income, the credit score, and the debt ratio, you may want to refinance your HELOC into a long term fixed rate mortgage. If not, make efforts to pay down your balance to keep your payments manageable!
Credit card borrowers are likely to see an increase in interest rates and payments, even though credit card interest rates are already sky high. If you can pay those credit cards down, do so . For those who use 0% credit cards to roll balances from one period to another, expect that the 0% interest rate period will shorten over time: you will have to roll over balances more often.
From an income standpoint, long suffering fixed income investors are not out of the woods yet. As the Boston Globe reported me saying in October, the very modest increase in the Fed Funds rate will not yet trigger an increase in bank and CD rates sufficient to cause a stampede from mattresses to CDs. However it is a marginal improvement, and perhaps savers will be rewarded with increased returns as rate hikes continue over the next few months and the next few years.
Investors saw the stock market close up on the day of the Fed’s announcement, with the S&P 500 closing at 2,073.07. Clearly, the market was not spooked by the modest .25% increase , or the prospect of more increases next year. This may be an opportunity to do a portfolio check and ensure that you maintain a well diversified portfolio that is adapted to your needs, risk tolerance and time horizon. In particular you will want to understand the impact that your bond allocation will have on your portfolio.
If you have not done so already, schedule a review on your debt and investment strategies with your CERTIFIED FINANCIAL PLANNER™ Professional.
A previous version of this post appeared in the Boston Globe’s Managing Your Money blog