The Federal Reserve has caused quite a stir over the last few months with inconsistent messages regarding its time line for raising interest rates. In January, Michael Gapen, former Fed monetary policy division head, told USA Today that, “I think they’re in a wait-and-see mode, and they’re still sticking to their mid-2015 guidance.”
In mid-February, however, the Fed’s meeting minutes indicated that they might not raise rates until later in the year. “Nonetheless, a number of participants suggested that they would need to see further improvement in labor market conditions and data pointing to continued growth in real activity at a pace sufficient to support additional labor market gains before beginning policy normalization,” the minutes stated.
And finally, on March 18 the Fed issued a policy statement that it would indeed consider raising rates as early as June, albeit more gradually than officials first estimated. Current estimates put the federal funds rate at 0.625 percent for the end of 2015—still more than double the long-standing 0.25 percent but roughly half the 1.125 rate predicted in December.
Despite the uncertainty, it does seem safe to assume a hike will occur in the near future. “The Fed has kept interest rates the same since 2009, and at some point soon they’ll have to increase them,” said Kyle O’Dell, President of Secure Wealth Strategies. “The longer they wait, the greater the long-term risk to our economy.” The Fed has long waited for the job market to improve, but despite falling unemployment, labor force participation is still declining (Bureau of Labor Statistics) and real wages have barely risen since 2010 (Center for American Progress). In the meantime, asset bubbles have only grown larger.
What will a rate increase mean for current retirees? “Retirees in general ought to be more risk-averse, and a rate increase would only exasperate that need to shift money into safe money positions,” said Dan White, President of Daniel White and Associates. With a correction in site, few retirees will want to maintain significant holdings in an already volatile market.
Even a small rate hike could also bode poorly for seniors big on bonds. “Anyone with a big bond portfolio needs to know that as interest rates go up, you’ll have falling bond prices,” said O’Dell. Clients who still have a decade or more to work may have a shot at higher-yield bonds if the market normalizes before they retire, but current retirees shouldn’t bank on it. Over the next year, and particularly as the Fed begins to solidify its plans, retired clients will need to move some of that money into other securities to offset the price drop.