After years of waffling on a more aggressive interest rate agenda, the Federal Reserve is indicating change may be ahead. Earlier this month, a new employment report showed the U.S. added 235,000 jobs in February. With job growth, wage growth, and other indicators on the rise, the Fed decided to raise the federal funds rate – or the rate for overnight loans – to a target range of 0.75-1.0%. In turn, it will affect interest rates nationwide – from credit card rates and lending rates to mortgage interest rates and more.
This hike comes after a three-month impasse – the last time the Fed increased its benchmark rate was in December 2016. As a New York Times article noted, this is the Fed’s third rate hike since the financial crisis of 2008-2009.
Now, how can this affect retired and near-retired investors - and does it mean future interest rate hikes?
More Rate Hikes in the Near Future?
With the rate increase, additional rate increases may well be in order. Jim Paulsen, chief investment strategist at Wells Capital Management, believes it could be more than just a one-time event. “I think it’s more than a March rate hike,” he said to Jeff Cox, Finance Editor with CNBC. “They’re putting themselves on a schedule for three to four rate hikes a year.”
The CME Group’s tracking tool indicates that traders expect the Fed to stay committed to its recent hike -- and possibly more hikes in the future. Take, for instance, the next scheduled Fed meeting in May. According to the FedWatch tool, traders assign a 93.6% chance of the rate remaining at 0.75-1.0% at the Fed’s meeting on May 3, 2017 (as of March 20, 2017). You can see possibilities for yourself by clicking here to the CME Group site.
Source: CME Group, FedWatch Tool, http://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html, Probabilities as of March 20, 2017, 12:35pm CT. All rights reserved.
Why Does This Matter?
With the stock market at all-time highs, many retirees and investors close to retirement worry about their money. How much of their retirement money should be in equities – and how much is “too much?”
There is also the danger of overconfidence. Stock prices are at record highs, market volatility has been low, and investors feel bullish about the market. The CBOE Volatility Index has hovered slightly above 11.0, as investors expect market volatility to remain low. This recent trend of lowered investor fears about the market can be seen in the graph below.
Source: Chicago Board Options Exchange, CBOE Volatility Index: VIX© [VIXCLS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/VIXCLS, March 20, 2017.
But as the value of investments in equity holdings rise, so does the risk of portfolio losses due to a market decline. This brings up the question of where to keep retirement funds safe from down-market effects. Generally speaking, bonds have been treated as a “safe haven” to preserve money from market downturns. But bond values can be affected by interest rate movements.
When interest rates go up, bond values go down, as historical events show. And with more interest rate hikes possibly on the horizon, bonds likely won't offer the same safety and security as they have in times past.
"Rising interest rates, debt levels at historic highs in both corporations and households, structural problems with the aging labor market, all point to a heightened risk in markets," as Suzanne Hutchins, lead portfolio manager at Dreyfus/Newton Global Real Return Fund, said to MarketWatch correspondent Anora Mahmudova.
Future Bond Prospects?
Jennifer Ellison, financial advisor and principal at the wealth management firm BOS, shared with Mahmudova some insights for possible bond prospects. "Hidden risk in portfolios comes from high-yield bonds and long duration. When interest rates rise or inflation increases, these assets will have much bigger losses than people realize," she said. "In the old days, you’d go more conservative and probably increase your bond allocation, but bonds are also risky right now."
As Mahmudova notes, yields on a 10-year Treasury have declined from a last-year spike of 2.6% to the 2.3% mark in February 2017. Today, March 20, 2017 its market-opening value was at 2.5%.
Michael Hasenstab of Franklin-Templeton Investments believes investor indifference to interest rate risk may be a danger. "... A bigger issue is that people are very complacent about interest-rate risk and are very complacent about the risks of the bond market. If you look at the underlying fundamentals, inflation is rising, growth is resilient," he told Emma Wall of Morningstar. "President Trump's proposals all are stimulative for both growth and inflation. So, maybe the Fed hikes two more, maybe they don't, but the reality is, either they hike and normalize and prevent getting behind the curve and or the market will do it for them."
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