The Federal Reserve Bank’s Open Market Committee adjusts rates, down to stimulate the economy when needed, and up control inflation and prevent the economy from overheating during times of growth. In the first several years after the Great Recession, people thought little about rates. The Fed’s target rate fell to 0% late in 2008 and stayed at 0% for 7 years. Such extended periods of low rates is highly uncommon, and mortgage rates fell to historic lows, and bank savings accounts paid “goose eggs” …almost 0%.
As the economy improved, the Fed raised rates 7 times since late 2015, two of which happened in 2018. But, Fed the Fed target rate range still remains at a historically-low 1.75% – 2%, reflecting the Fed’s belief that the economy is fundamentally sound. Joblessness is low, while wages (at least before inflation adjustments), consumer spending and borrowing are creeping up, giving the Fed reason to move away from 0% rates, partly to there is dry powder for the next eventual recession, whenever it occurs.
How do rising rates affect investments? Existing bond prices drop, since new bonds at higher rates are more attractive. Fed rate adjustments affect short-term bonds directly, while indirectly impacting longer-term bonds, since longer-term bonds are driven more by inflation numbers. But remember, a some short-term bond volatility due to rates eventually leads to higher returns, as newer higher-rate bonds get added to an investor’s bond portion of their portfolio.
Banks were not quick to increase savings account interest rates as the Fed’s target rate went up, but eventually responded and savings account and CD rates are now up to over 2%. For borrowers, higher Fed rates cause new loans and variable rate loans to be more costly, in particular home equity lines of credit, due to the law changes that can reduce interest tax-deductibility. However, for borrowers who already have fixed-rate mortgage loans will effectively pay less each month on a disposable-income adjusted basis, if inflation is rising, and if incomes rise at least someone over time with inflation, while fixed rate loan payments remain static.
Will there be more rate increases? Almost certainly, yes. The Fed states they will increase rates further through 2019 if the economy keeps growing, in order to keep it from getting red hot. At the same time, the Fed also rates to level out at a level that is lower than the historical average, since while the economy is solid, it is expected to grow at a lower rate than the historical average.
Should you make any decisions based on the expected continued rise in rates? Today may be a better time to get a mortgage than tomorrow… but real estate prices are at new highs, so no easy answer there. In terms of investments, there is no crystal ball. In a New York Times article, 4/20/10, titled “Interest Rates Have No Where to Go But Up,” famous investment specialists predicted rates would rise 1.5% by the end of 2010. They were correct about the increase, but wrong about when… by 7 years. Rates hadn’t increased by a sum of 1.5% until early 2018, further illustrating that a disciplined, patient, long-term strategy and perspective is often most effective in the long-run.