What a Fed rate hike in 2016 means for your money
Get ready: This time, it's for real. No more false starts, a Fed rate hike is coming — eventually.
The Fed's decision to raise interest rates in 2016 has been postponed up to now. For a while this summer, a spate of positive economic news made it look like the Fed finally was ready to raise interest rates.
It's possible such a hike could happen as early as this week's Fed meeting. Federal Reserve Board Chair Janet Yellen has made comments recently that indicate she is ready to hike.
"In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months," Yellen said on Aug. 26 during a speech at a Federal Reserve Bank of Kansas City symposium in Jackson Hole, Wyoming.
However, softer economic data in the past couple of weeks — including a weaker-than-expected September jobs report — has convinced most observers that a rate hike again will be delayed until later this year.
A Fed rate hike is inevitable at some point. When such an increase finally moves from speculation to reality, it could have a big impact on your wallet. The Fed indirectly influences many interest rates because it controls the federal funds rate. This is the interest rate that major banks and credit unions charge each other when lending money.
Here's a clear picture of what a fed rate increase and higher interest rates will mean for your wallet:
1. Mortgage Rates Might Rise
The impact of a federal funds rate increase on mortgage interest rates remains unclear. Potentially, the initial interest rate hike could raise rates on the long-term bonds used to set mortgage rates. Yet, 10-year Treasury bonds are also influenced by inflation expectations and the worldwide economic outlook. In the short term, adjustable-rate mortgages and home equity lines of credit would be more sensitive to a fed interest rate hike.So, although it's impossible to say exactly how a rate hike will impact mortgage rates, it might be best to eliminate uncertainty. If you're seeking a new home mortgage or considering refinancing an existing one in the near future, you might want to lock in a loan sooner rather than later.
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2. Auto Loan Rates Could Trend Higher
Auto sales hit a record in 2015 at approximately 17.5 million vehicles, according to a Wall Street Journal report. Although the Journal reports that auto sales have been strong this year, they declined sharply in August.
A small rise in the federal funds rate shouldn't affect car buyers too much, as dealers might subsidize lending rates in order to juice car sales if they continue to lag.
At the time of the last federal funds rate hike in December, 48-month auto rates finished the year at 4 percent. The 48-month rate had risen to 4.33 percent by the second quarter of this year, further reflecting the impact of the December rate hike.
Should interest rates continue to rise, auto loan rates will likely follow suit. The next rate hike — whether in September, December or beyond — is predicted to be small. So, it's unlikely consumers will be impacted in any significant fashion in the short term. Dealers want to keep new cars moving, and thus are motivated to continue offering incentives.
Related: 8 Options When You Can't Afford Your Mortgage Anymore
3. Money Market Accounts Are Not Likely to Rise Quickly
Older readers might remember the 1980s and 1990s, when you could get higher interest rates on your cash. Today, you're lucky if you can snare a 1-percent return on your money market account. In spite of last December's small bump up in the federal funds rate, you probably won't see higher rates immediately.
There is a ripple effect after the Fed's announcement of a federal funds rate hike. It takes some time before higher rates are implemented across the economy, and that includes in money market accounts.
4. Bank Deposit Account Interest Rates Will Hold
Even if there is a Federal Reserve interest rate hike, you probably won't see higher interest rates on your checking and savings accounts. Despite last December's rate increase, rates have risen slowly in the past 12 months.
In general, when the Fed raises rates, savings rates rise at a slower rate than borrowing rates.
5. Credit Card Interest Rates Should Not Spike
Credit card interest rates are variable, and somewhat sensitive to hikes in the federal funds rate. As interest rates go up, your credit card rate will follow. Yet, don't expect a huge spike, as recent legislation prevents lenders from quickly hiking the rate on existing balances in most cases.
6. The Stock Market Might Have a Rocky Ride
Stock prices are driven by a variety of factors, including the economy, expectations and interest rates. In the short term, stock prices are random. Over the long haul, profits generally drive the growth of individual companies and their stock prices.
Stocks have risen sharply in recent years. By historical standards, they are expensive. The Shiller PE Ratio — a well-respected valuation measure of the stock market — recently has hovered around 27, well above the mean value of 16.69. Although stock prices are usually flat after a small interest rate rise, today's high stock prices mean that regardless of the future interest rate picture, you can expect some market volatility going forward.
Read: 13 Investing Tips for Beginners
7. The U.S. Dollar Might Strengthen
When U.S. interest rates rise, yield-seeking foreign investors tend to buy U.S. Treasury bonds and notes, which are viewed as the most stable investment worldwide. As more foreign dollars come into the country, the U.S. dollar becomes more valuable when compared with foreign currencies.
Higher interest rates offer pros and cons. Travelers benefit from a stronger dollar, as it makes their international vacation more economical. On the other hand, global companies have greater difficulty selling U.S. goods abroad, as their prices become relatively higher. Such a reality hurts U.S. exports, and it could erode consumer confidence if profits falter at many large multinational companies.
8. A Rate Hike Means the Economy Is Doing Better
A federal rate hike happens when the economy is growing. As Yellen stated in her recent speech at Jackson Hole, the U.S. economy is expanding as consumer spending improves. The labor market has its ups and downs, but generally is improving.
Yellen and the Federal Reserve Board expect inflation to rise to 2 percent, and the job market to continue expanding. Thus, the next Fed rate hike date might be the first in a string of ensuing Federal Reserve interest rate bumps.