The Federal Reserve isn’t going to be “patient” any more. Dropping that one word from the language surrounding policymakers’ approach to future interest rate hikes may seem minor, but it’s a significant change for savers, investors and borrowers.
Last December the Fed signalled that the era of ultra-low interest rates was coming to an end. But it added it would patient about deciding when. Wednesday’s decision to drop the P-word throws open the doors to the first increases in lending rates since 2008, and means that Janet Yellen and her fellow Fed officials will respond to economic data on a meeting-by-meeting basis.
It’s time to bid a final farewell to the long-term commitment to keeping interest rates low just in order to keep the economy chugging along.
This is far more than a matter of semantics, or even a policy change. All things being equal, this wording change is the next step leading toward Americans seeing higher interest rates on our credit card bills. Once the Fed boosts its own key rates, our mortgage interest rates will certainly follow suit, as will the financing costs of all the other debt on our personal balance sheets.
Yellen may have calmed the stock markets on Wednesday, saying that axing patient “does not mean we are going to be impatient.” But in the longer term the end to the Fed’s policy of keeping its key Fed funds rate at nearly zero will create tremendous uncertainty within the financial markets. Already that prospect has caused jittery investors to dump their holdings of bond mutual funds, aware that higher interest rates will make existing bonds with lower income streams less attractive than newer ones.
What does all this mean for the rest of us, who will feel the impact of those interest rate changes, whenever they take place, throughout our financial lives?
For now, and for the forseeable future, you can count on volatility. Lots of volatility.
“We went through a period of total lack of volatility for very long,” IMF director Christine Lagarde warned earlier this week, anticipating the Fed’s wording change. That means that even if the Fed moves as slowly and cautiously in the direction of higher interest rates as policymakers’ actions to date suggest, telegraphing their every move far in advance, the experience is still going to be unnerving.
Then, too, the market’s anticipation of what is to come can be far, far more bumpy. While formal Fed interest rate hikes certainly will trigger higher lending costs, so, too, can anything that suggests that the Fed will act soon. Consider the market’s response to the unexpectedly strong employment report released at the beginning of March. When the Labor Department announced that the US economy created 295,000 new jobs in February, the average interest rate for a 30-year fixed rate mortgage jumped to 3.86% from 3.75% the previous week; that was well above the 3.59% low recorded in early February. The rate increase quickly reversed itself when the immediate panicky response to the data (“omg, this means the Fed will raise rates now!”) abated.
We’ve already had a taste of what happens when investors feel they can’t get a grip on a key factor they need to make their decisions: interest rates. That’s the “taper tantrum” of 2013, when the Fed first contemplated ending its active support of the financial markets by wrapping up its bond-buying program. Ironically, when investors panicked and drove stock prices down and market interest rates up, they caused the Fed to back off. That postponed the day when policymakers would boost the Fed funds rate out higher borrowing costs would damage the economy.
While the change in language makes it clear that the Fed’s next move will be to raise interest rates – no real surprise for anyone who has been keeping an eye on events – there is still no indication of when that move might come. You can rule out April – the Fed’s statement says that timing “remains unlikely.” But June is a real possibility, although Yellen commented during the press conference that followed the meeting’s end that “just because we removed the word patient from the statement doesn’t mean we’re going to be impatient.” Essentially, it’s all a recipe for a very volatile six months.
In the short term, you’ll want to look very carefully at your Treasury bond investments. While stocks that pay dividends have already taken a beating this year, reflecting the fact that income-generating investments will fall out of favor if interest rates rise and investors will be able to buy newly-issued bonds generating higher streams of income in the not-too-distant future, many pundits feel that Treasury securities are still overpriced, perhaps because of their traditional role as safe havens. That said, this month’s withdrawals from bond exchange-traded funds suggest that investors are waking up to that risk: as of March 16, they yanked $6.1bn from these vehicles. If that pace continues, withdrawals are on pace to hit a monthly record, according to TrimTabs Investment Research data.
All of this means becoming much more wary of bonds, winnowing through your stock portfolio in search of stocks that are exposed to interest rates (such as utilities) or that might suffer in a higher dollar environment since they earn a big chunk of their profits in a foreign currency. (The higher the interest rate is in the US relative to other countries, the more people will want to park some of their assets in dollars to capture a return on their money.)
Take a look at the makeup of your debt, too. Is your mortgage a floating rate loan? Do you have any other floating rate debt? If so, this might be the right time tolock it in place at a low rate. Mortgage rates are the lowest that many lenders have witnessed in their lifetimes; given the Fed’s clear signals, do you really want to delay acting on this?
If you’ve been contemplating taking out a loan to make some home improvements, to buy a second home, or for some other purpose – and assuming that you’re in a financial position to handle the payments of course – this is probably a good time to think about the timing of your plans. While the Fed clearly won’t send interest rates soaring in response to a perceived inflation threat, making it impossible for you to pursue your dream, you can’t rule out the fact that market volatility might make financing more costly or less accessible than it is today.
Just as the Fed’s actions will unfold in what will feel to anxious observers like slow motion, so, too, the reactions won’t all be immediately visible. For instance, that house that you pay $250,000 for today may find it a little bit harder to hang on to its value, to the extent that higher rates might take a bite out of the housing market’s recovery and curb appreciation in home valuations.
Farewell to patience. Welcome, turmoil and uncertainty.
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