Higher Interest Rates: What Does It Mean for Consumers, Bond Investors and the Stock Market?

Given the circumstances, there is a real potential for wage inflation

After a decade of extraordinarily low interest rates, the game is now over. At its meeting in September, the Federal Reserve Board raised rates a quarter point and made clear that another hike will happen before year-end. That last hike – the third this year – has caused the yield on the 10-year Treasury bond to jump from a historical low of 1.46 percent in July 2016 to 3.16 percent today.

This is a huge move up in interest rates, but what does it mean for consumers, bond investors and the stock market?

First, it’s important to explain why the Fed has been raising short-term interest rates.

With the U.S. unemployment rate at 3.7 percent and the demand for workers getting tighter, there is a real potential for wage inflation. If the Federal Reserve gets behind the eight ball on inflation, bond investors will lose money on bonds with longer maturities. Chairman Jerome Powell also needs to raise rates to a high enough level that if a recession arose, cutting rates would, in fact, stimulate the economy.

For consumers who have financed their homes with adjustable rate mortgages – now is the time to reconsider that strategy. If you haven’t locked in a fixed interest rate for 15 or 30 years, it is time to consider doing that. The rates on 30-year mortgages just topped 5 percent for the first time since the spring of 2011 and could be headed even higher if the Fed comes through on its promise of three interest rate increases in 2019. That could potentially push 30-year mortgage rates to close to 6 percent.

The same goes for automobile loans. Auto dealers have enticed consumers to buy a lot of new cars with cheap money over the past decade; but those low interest rate loans may now be a thing of the past.

Rates on student and commercial real estate loans could also be impacted by the Fed’s rate hikes. It is definitely worth checking all outstanding loans to see if they are adjustable, how often they adjust and if there is any way to lock in a long-term, fixed interest rate. It may be more expensive in the short term because your adjustable rate could still be a little cheaper, but on a long-term investment like a house or student loans, it could save a lot of money over the next 15 to 30 years.

If you have questions about how your loan terms impact your retirement planning, we of course are more than happy to help you assess those options. 

Bond investors will likely see a decrease in the value of their investments in a higher interest rate environment. Bond prices trade inversely to yields, meaning as interest rates rise, bond prices decline. Individuals buy bonds for the coupon or interest rate, but if interest rates rise too rapidly, there can be some serious price declines on longer-term debt. A 1 percent movement in interest rates on a 10-year bond can mean a 10-percent-decline on the principal value of that investment. This year, bond investors have actually lost money on bond investments because of rising interest rates, which hasn’t happened very often during the last 30 years.

The stock market in general doesn’t like higher interest rates because stocks that pay generous dividends compete with risk-free bond investments like treasury bills. During the zero-interest rate era in the midst of the financial crisis, stocks actually paid more in income than bonds. The only other time this occurred was in the 1950s. Stocks that pay the highest dividends – including those in the consumer staples, utility, telecom and real estate sectors – will likely get hit the hardest by high interest rates.

Categories: Economy/Politics