Fed Raises Rates; So What Should Clients Do?

The Fed's latest move has implications for investments and management of short-term variable debt

Fed chief Janet Yellen. Fed chief Janet Yellen.

The Federal Reserve today did just what the financial markets were expecting: It raised the key short-term federal funds rate by 0.25% to a range between 0.75% and 1%.

“The Fed told us what they were going to do and just did it and did it without changing their economic forecast,” said Vince Reinhart, chief economist for Standish Mellon Asset Management who spent 24 years working at the Fed. “It plans to tighten three times this year. The Fed is executing a plan.”

(Related: Gundlach: Fed to Raise Rates ‘Until Something Breaks’)

In other words, the Fed will hike rates two more time in 2017, most likely in September and December, said Reinhart. Vanguard’s chief economist, Roger Aliaga-Diaz, expects the next rate hike could come as early as June, as do IHS Markit economists Nariman Behravesh, Sara Johnson and Ozlem Yaylaci, “if job growth continues at the pace of January and February.”

In addition to hiking rates, the Fed today also released its latest projections for the U.S. economy and fed funds rates through 2019, showing little or no change from projections made at its last meeting in December.

GDP forecasts were unchanged with median forecasts at 2.1% for 2017 and 018 and 1.9% in 2019. The median unemployment rate projection remained at 4.5% for all three years and the project for core PCE inflation, its favoriate inflation indicator, rose slightly to 1.9% from 1.8% for 2017 and remained unchanged at 2% for the remaining years.

Its fed funds forecast was unchanged at 1.4% for 2017, 2.1% for 2018 but rose slightly to 3% from 2.9% for 2019.

Fed chair Janet Yellen, in a press conference following today’s policy move, said the central bank’s projections are “essentially unchanged” since December and iterated that Fed “policy is not on a preset course” and will depend on changes in the economy as well as changes in fiscal policy which “can influence” its outlook. “We will continue as always to assess economic conditions,” said Yellen.

Financial markets seem pleased with the Fed’s move today.

The Dow shot up more than 60 points on the move, for a gain of more than 100 points by midafternoon, while Treasury yields retreated slightly with the 10-year note, falling to 2.5% from 2.57% earlier in the day, and the dollar fell against major currencies.

Equity investors are likely viewing the move as seeing the economy strong enough to remove “unusual accommodation” and bond investors as being more confident that the Fed will not let inflation get out of hand, said Reinhart.

Managing Debt

The Fed’s move has a dual impact for financial advisors: on client portfolios and client debt management.

The more immediate effect is on the latter, with rates increasing on adjustable-rate debt such as credit cards and home equity lines of credit (HELOCs). Longer term, “people in the market to purchase homes will see higher rates as well,” says Greg McBride, chief financial analyst at Bankrate, refering to fixed-rate mortgages, whose rates are pegged to long-term interest rates such as the 10-year Treasury.

Thirty-year fixed mortgage rates are now about 4.38%, or 75 basis points higher than six months ago and at their highest rate since 2014.

Given the expectation for several more Fed hikes this year, McBride suggests that homeowners refinance mortgage debt into fixed-rate loans now, lock in a fixed-rate loan if they’re within 30 to 45 days of closing on a home purchase, and pay down adjustable-rate debt like credit card debt as soon as possible. “Grab zero percent credit card offers to pay off debt once and for all,” said McBride.

“Do anything you can do to make headway on debt – driving for Uber, freelance work. It’s not going to get any easier.”

As for the impact on investments going forward, Paul Eitelman, multi-asset investment strategist at Russell Investments, wrote that he’s “less negative on the outlook for U.S. government bonds in global multi-asset portfolios” but that “U.S. equities have moved well ahead of earnings fundamentals and appear vulnerable to policy risk if federal tax reform is watered down or delayed.”

Matthew McAller, managing director and portfolio manager of Cumberland Advisors, told ThinkAdvisor that investors should not get “overly concerned about duration,” which measures the price sensitivity of a bond to interest rate changes, “because in every 20-year rolling period for the last 80 years or more, 97% of total return is due to compounded interest. If you stay in two-year paper you’re giving up too much compounding ... You can’t let duration scare you out of a coupon.”

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