When Will Interest Rates Go Up?
Are You Ready for Higher Interest Rates?
Interest rates stopped rising in 2019. But rates for savings accounts, mortgages, certificates of deposit, and credit cards rise at different speeds. Each product relies on a different benchmark. As a result, increases for each depend on how their interest rates are determined.
All short-term interest rates follow the fed funds rate. That's what banks charge each other for overnight loans of fed funds. The Federal Open Market Committee raised the fed funds rate by a quarter point at its Dec. 19, 2018, meeting. It then lowered it three times as of October. The Committee is concerned about sluggish global economic growth, despite positive jobs reports at home. It would also prefer to see inflation rates a little closer to its 2% goal.
When Will Interest Rates Go Up?
As of December 2019, the current fed funds rate range was 1.5% to 1.75%. The Fed expects to keep it there through the end of 2019. The Committee began raising rates in December 2015, after the recession was safely over.
Long-term rates follow the 10-year Treasury yield. As of December 2019 the 10-year Treasury yield was 1.83%. Normally, as the economy improves, demand for Treasurys falls. The yields rise as sellers try to make the bonds more attractive. Higher Treasury yields drive up interest rates on long-term loans, mortgages, and bonds. The chart below depicts former interest rates, and the projections for the future. There are five steps you can take to protect yourself from higher interest rates.
Savings Accounts and CDs
Interest rates for savings accounts and certificates of deposit track the London Interbank Offer Rate. That's the interest rate at which major international banks are willing to offer Eurodollar deposits to one another. Banks may pay you a little less than Libor so they can make a profit. Savings accounts may follow the one-month Libor rate, while CDs may follow longer-term rates.
Credit Card Rates
Banks base credit card rates on the prime rate. It's what they charge their best customers for short-term loans. It's 3 percentage points higher than the fed funds rate. Banks can charge anywhere from 8% to 17% more for credit card rates, depending on your credit score and the type of card. It's a good idea to pay off any outstanding balances now in case rates get higher.
Home Equity Lines of Credit and Adjustable Rate Loans
The fed funds rate guides adjustable rate loans. These include home equity lines of credit and any variable rate loans. As the fed funds rate rises, so will the cost of these loans. Pay them down as much as you can to avoid any surprises. Where it makes sense, talk to your bank about switching to a fixed-rate loan.
Auto and Short-Term Loans
Fixed interest rates on three- to five-year loans don't follow the prime rate, Libor, or the fed funds rate. Instead, they are a few percentage points higher than one, three, and five-year Treasury bill yields. Yields are the total return investors receive for holding the bills.
The U.S. Treasury sells Treasury bills, notes, and bonds at an auction for a fixed interest rate that loosely tracks the fed funds rate. Investors can then sell them on the secondary market. Many other factors influence their yields. These include the demand for the dollar from forex traders. When demand for the dollar rises, so does demand for Treasurys. Investors will pay more to buy them. Since the interest rate doesn't change, the overall yield falls.
Demand for Treasurys also increases when there are global economic crises. That's because the U.S. government guarantees repayment. All these factors mean interest rates on long-term debt aren't as easy to predict as those based on the fed funds rate.
On the other hand, as investors receive more yield for short-term bills, they'll want a higher return for long-term notes. But if they lose confidence in the economy, they will buy long-term bonds regardless of the yield on short-term bills. That will flatten the yield curve. If they fear a recession, they will prefer long-term bonds to keep their investments safe. If that happens, the yield curve inverts. The Treasury yield curve inverted each of the last seven recessions. The yield curve also predicted the 2008 financial crisis in 2006.
When rates are rising, it's best to keep your fixed-rate loans. Rising interest rates won't affect them. But if you need a new loan, apply for it now before rates rise further.
Mortgage Rates and Student Loans
Banks set fixed rates on conventional mortgages a little higher than the yields on 10-year, 15-year, and 30-year Treasury bonds. Interest rates on long-term loans rise along with those yields. The same holds true for student loans. Mortgage interest rates closely follow Treasury note yields.
Now is not the time to refinance a fixed-rate mortgage for an adjustable rate. For new home buyers, don't get an adjustable rate mortgage just to afford a bigger house. It's better to get a fixed-rate loan, even if it means you can only afford the smaller house.
State, municipal, and corporate bonds compete with U.S. Treasurys for investors' dollars. Since they are riskier than U.S. government bonds, they must pay higher interest rates than Treasurys. That's true for all other types of bonds.
Fitch, Moody's Investors Service, and Standard & Poor's are the main agencies that rate the risk of default. Bonds with the most risk, called high-yield bonds, pay the most return. When Treasury yields rise, so do these bonds to remain competitive.
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Federal Reserve Bank of San Francisco. "What Is Libor and Why Do Libor Interest Rates Move Closely in Line With Short-Term Interest Rates in the U.S.?" Accessed Dec. 10, 2019.
Board of Governors of the Federal Reserve System. "What Is the Prime Rate, and Does the Federal Reserve Set the Prime Rate?" Accessed Dec. 10, 2019.
Consumer Financial Protection Bureau. "The Federal Reserve Board: Consumer Handbook on Adjustable-Rate Mortgages." Accessed Dec. 10, 2019.
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