The case for a rate hike isn't a lock. But if you stay in touch with your clients and let them know your thinking, a rate hike will be easier on everyone.
When clients ask Mark Bass, a financial planner in Lubbock, Texas, about when he thinks the Federal Reserve will raise interest rates, he has a ready answer. “Most often, our response is that we've been saying that for five years,” Mr. Bass says. “Our credibility is pretty well shot when it comes to that particular topic.”
And, in fact, you could have made a decent argument for the Fed raising its key short-term interest rate pretty much at any time in the past five years. While the miserable May jobs report on Friday would seem to preclude a June rate hike, the Fed could move any time in the next few months.
As it stands, inflation is not particularly hot at the moment. The GDP price deflator for personal consumption expenditures, the Fed's favored inflation indicator, has gained 1.6% the past 12 months. The Fed is aiming for about 2% inflation.
The economic statistic most likely to push the Fed toward raising rates is average weekly wages, which have gained about 2.5% the 12 months ended April. The movement to increase the minimum wage to $15 an hour increases the upward pressure on wages. Typically, when unemployment falls and wages rise, inflation rises as well. You can't have a wage-price spiral without rising wages.
The Fed might have an unspoken reason for raising interest rates as well. It needs some ammunition if the nation slips back into recession. Lowering the fed funds rate to zero from its current 0.25% to 0.50% isn't going to be much stimulus. If they raise interest rates now, “At least they would have a couple arrows in the quiver,” Mr. Bass said.
Most clients realize that rising interest rates aren't good for their investments. When interest rates rise, companies have to pay more interest on their debt, and prospective homebuyers will have to shell out more for a mortgage. Furthermore, risk-free investments, such as money funds and bank CDs, become more attractive vs. stocks and bonds. What should you tell them?
THAT CONVERSATION WITH CLIENTS
1. It's not a lock. The fed funds futures market puts the odds of a Fed rate hike in June at 21% before the May jobs report, says John Lonski, chief economist for Moody's Capital Markets Research Group. Those odds have gone down swiftly since then. And that means a rate hike is unlikely this month. “Since 1994, the Fed has never raised rates unless the fed funds futures markets puts the odds at 60% or more,” he said. If the Fed passes on the June interest rate hike, it faces the prospect of raising rates at the July 27 meeting, which is during the Democratic convention.
2. It's not the end of the world. The current fed funds target is 0.25% to 0.50%. A quarter-point hike would lift the range to 0.50% to 0.75%. Those are still extraordinarily low rates. Your clients might see a modest increase in their credit-card rates, but that's all the more reason for them to pay down consumer debt. On the plus side, they could see a modest increase in the return on their cash. The average money market fund now yields 0.1%, up from 0.03% at the start of the year. High-yielding bank rates have moved from about 1% to 1.25%, according to Bankrate.com.
3. It isn't necessarily bad for stocks. Normally, the stock market views rising rates as a confirmation that the economy is growing and that the demand for loans is rising. The Fed last raised rates on Dec. 17, 2015; the Standard & Poor's 500 stock index has gained 2.19% since then, including dividends. And the last major round of rate hikes began in 2004; the stock market didn't tumble until late 2007.
4. It can be remedied. You can reduce (but not eliminate) any untoward effects of interest rate hikes by reducing investments that are highly sensitive to higher rates, such as long-term government bonds. Bear in mind that higher short-term rates may also hurt other investments that aren't fixed income.
5. It can't be downplayed. The best thing for a financial adviser to do is to make sure your clients know you are thinking about the effects of a rate hike and what they should be doing, said Gary Fullam, chief investment officer at Globalt. “You need to be having conversations with them and they need to know where you stand,” he said. “They know our thinking about it, and we've talked a lot about it.”
Clearly, no one knows what the Fed will do, or when it will raise interest rates. The case for a rate hike certainly isn't a lock. But if you stay in touch with your clients and let them know your thinking, a rate hike will be easier on everyone.
