The Federal Reserve and Rates: What To Do To Avoid Slowly Rising Rate Increases

The Federal Reserve and Rates: What To Do To Avoid Slowly Rising Rate Increases

Keeping an eye on the Federal Reserve can often become a frustrating experience because it’s often hard to predict when they’ll raise interest rates. For someone like you who plans to do some investing, it could become tricky, considering interest rates are already on a gradual rise.

The fed funds rate went up slightly in June, and it’s expected to go to 3% by 2019. In turn, this is going to affect interest rates as well, making any kind of investment either positive or negative.

If you have any current debt, it can also pose a big problem, especially if you need a loan for a major investment.

Here are some things to do this year so you can beat the inevitably higher interest rates coming over the next year or two.

Pay Off Your Debts As Quickly As You Can

Can you pay off (or pay down) your debts this year? If you can, you’ll be able to avoid rising rates on your credit cards in the near future. Of course, how much interest you pay may differ based on your credit score and the type of card you use.

Most credit card interest rates are already three points higher than the fed funds rate. This means it’s likely to go up significantly higher in two years than where it is now.

Stay away from auto or short-term loans as well. They base their interest rates on Treasury bill yields, making interest rates higher than you may know. Generally, they’ll be 2.5% higher than any Treasury note value over a three-year span.

Buy Any Assets You Need Now

Whether for personal or business purposes, you’ll want to make major asset purchases soon so you can pay them off faster before interest rates rise. Your business may need vehicles, furniture, or other assets to stay competitive, and you’ll probably need credit to buy them.

Buying now gives you a head-start on paying off sooner. The same goes with buying homes or commercial property. Investing in these, though, means potential higher rates on your mortgage later. Doing a fixed-rate mortgage is a smarter choice at this point.

Investing in Stocks and Bonds

Bonds are one of the best investment opportunities since they’re always reliable and a good source to turn to during economic downturns. They can hurt you, though, when interest rates go higher. Don’t just rely on these alone and try to diversify your portfolio as much as you can.

Investing in stocks is always best when interest rates go high. If you insist on keeping more bonds, a good workaround is to shorten maturities. Rather than keeping 20-30 year bonds, shorten them to 5-10 years. Doing so helps alleviate any losses from high-interest rates over the long-term.

A short-term bond ETF is often a popular investment to overcome this problem.

With stocks, you could take losses with high-interest rates, though fixable through some creative maneuvers.

Things to Avoid in Stock Investments

Yes, even stock investments can become affected by rising interest rates. As USA Today points out, what you invest in determines substantial profits or losses.

Over the next couple of years, you might want to get out of utilities, materials, or consumer discretionary stocks. These all dip dramatically when interest rates start rising.

The best stocks to invest in during these hikes are energy, technology, and health care. These are already strong, to begin with, though always stay more stable when the Feds raise rates. Overall, any stock not paying out dividends to their investors is safer.

Contact us at Apollo Consulting so we can help you make smart investment choices and other financial decisions when interest rates soar.

The Federal Reserve and Setting Rates

The Federal Reserve and Setting Rates

The Federal Reserve is one of the most powerful institutions in the country, but very few people know what they actually do. The Fed, as it is called, is lead by a board of economists chaired by Janet Yellen. The Fed was set up to help control the financial system with the goal of keeping employment low and inflation under control. The main way they seek to do this is by setting short-term inter-bank lending rates, which is an obscure yet extremely powerful way to impact virtually every economic transaction in the country.

The federal interbank rate is the percentage rate that banks lend money to each other. The Federal Reserve has the power to lower or raise these rates at will which they regularly do base on their analysis of the economy. This has a profound effect on the economy and financial transactions.

In particular, a low fed funds rate means that banks can lend money to each other cheaply and can then lend it out to customers cheaply. That, in turn, encourages businesses to borrow more money because the cost is less. Theoretically, if they borrow more money they will invest more in their businesses and hire more workers which will stimulate the economy. So the effect of lowering interest rates should be to improve the economy’s capacity.

On the flip side, anyone that saves money will be hurt by lowering interest rates. Because banks will be lending at lower rates, they will have lower profits and will not be able to pay depositors a higher rate. The people that have diligently saved funds in the bank will not be rewarded with interest on their money. They will have to take cash out of the bank and invest it into more aggressive opportunities such as municipal bonds, corporate bonds or equities. Again, this should serve to juice the economy by providing businesses with more cash to fund expansion. That produces more capital goods orders and more jobs.

So if lowering rates provides so many benefits, why would the Fed ever raise rates? The answer is that the Fed is keeping a balance between inflation and employment. If there is “over-investment” from too many loans and investments, then inflation will increase too quickly. The cost of gas, food, housing and everything else will rise and the poorest will be punished. Additionally, the if there is too much investment, the prices of assets could rise too quickly and eventually lead to a crash which causes far worse damage. For that reason, the Federal Reserve tries to keep the economy in relative balance by raising the interbank rate during periods of economic expansion.

Historically, the interbank rate has fluctuated wildly. During the 1980s, there was tremendous inflation and Fed Chairman Paul Volcker decided to raise the rate into the teens. In the short-term, that caused tremendous pain for businesses and other borrowers. In the long-term, it broke the curse of inflation and put the US economy on a path for massive expansion.

During the 2008 financial crisis, the economy went into a tailspin with all financial assets crashing towards zero. The Federal Reserve was in a bind and ended up dropping interbank rates all the way to zero. Chair Ben Bernanke knew that with an economy on the brink, interbank rates should not be holding any individual or company from borrowing and investing the proceeds.

Today, the Fed is slowly raising the rates again as the economy is expanding and has a low unemployment rate. Inflation is under control but has the potential to rise again. Only time will tell what the result of these interbanks rate changes will be.

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