Interest Rates 101: What consumers may expect from a hike

Posted By Scott Anderson In Economic Outlook,Your Finances | No Comments

As the Federal Reserve prepares to start raising interest rates, perhaps by year’s end, Bank of the West Chief Economist Scott Anderson, PhD, answered questions from our editorial staff to help demystify rising rates. The resulting three-part “Interest Rates 101” series looks at what the rate-hike process — or “normalization” of interest rates — could mean for consumers, businesses, exporters, and the U.S. and global economies.

In this segment, Scott addresses the possible implications for U.S. homeowners and investors.

Q: What do rising rates mean for homeowners and buyers?

Several young adults enjoying a dinner outdoors at a long table in a farm-like setting. [1]If you’re renting right now and you’re thinking about buying a home, now’s not a bad time to actually go out there and make the purchase. Mortgage rates aren’t going to get any cheaper, so now’s the time to move. Home prices are expected to continue to rise gradually even as the Fed raises interest rates.

The same thing goes with any big purchase, such as buying a car. While you still can see a lot of these low-rate deals for buying cars, you might not see that 12 or 18 months from now as rates move higher.

The longer you wait, the more expensive it’s likely to get from here. It’s not going to be a huge jump, so I’m not saying you have to go out tomorrow and buy a home. But definitely a year from now, two years from now, you may look back at the interest-rate environment today and say, “Wow. I should have done something then.”

What sort of impact might we see on personal savings?

With the Fed’s current interest-rate policies, savers have really been hurt by monetary policy. Short-term interest rates have been at zero for more than six years, and that’s driven down interest rates on checking accounts, savings accounts, and money market funds. Even bond yields have been below normal in this environment. So if you’re on a pension and you’re relying on investment income, that’s been a huge problem for your spending. But that’s going to change.

As the Fed normalizes rates, you’ll start to see it first in short-term rates. You’ll see checking- and savings-account interest rates move up in step with the Fed funds target rate. Money market fund rates will also move up as the market prices in these interest-rate hikes from the Fed, but it will be gradual. So you’re not going to go from zero to 1% returns overnight, but it’s going to be a gradual improvement.

When the Fed raises rates, will checking- and savings-account rates start to climb right away, or is there going to be a little bit of a lag?

There’s usually a little bit of a lag. Banks don’t change those rates on a dime. One thing you will probably see is a very quick adjustment in the prime rate. That’s the interest rate that banks charge their best customers for loans. Some types of business loans are priced off of the prime rate, and those usually go up almost the same day as when the Fed raises interest rates. It’s those savings-account and checking-account rates that usually take a while, so it might be several weeks before you start to see any real improvement there.

How about the bond market and the stock market: What typically happens as rates rise?

Usually the initial rate rise, especially if it’s not telegraphed by the Fed, will create some volatility in both the bond and stock markets. We’ve seen a little bit more volatility recently in both the bond and stock market, for example, but a lot of that has been driven more by events overseas than what the Fed’s been doing. I suspect that the stock and bond markets will digest the move fairly readily when it happens, because I think Janet Yellen and the Federal Reserve have been very careful to telegraph this properly.

So no major ramifications for the stock market?

Stocks have had a huge run since 2009, more than doubling. We have been trading near record high levels in a lot of the stock indexes. When we look at the price/earnings ratio, a way of valuing stocks whether they’re cheap or expensive compared to earnings, we’re at the higher end of normal ranges. So there is some room for a correction in stocks, but we’re certainly not expecting a sell-off like we saw during the Great Recession.

It’s pretty normal for markets to have those sorts of corrections periodically, and that’s something I wouldn’t rule out; but it shouldn’t be a huge problem for investors or for the economy.

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[2] Interest Rates 101: How a hike may change U.S., global economies:

[3] Interest Rates 101: What businesses may expect from a hike:

[4] Infographic: Are you rate-hike ready?  :

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