When interest rates change, the right moves to make as a saver and investor can change, too. The current challenge: It’s unclear whether rates are heading up or down.
This week, investors got a few clues from the Federal Reserve, the U.S. central bank often called “the Fed.” Its role is to keep our economy healthy, which it does, in part, by setting a benchmark interest rate called the federal funds rate. That influences the rates banks charge you on products like credit cards, auto loans, or mortgages.
The Fed’s latest plan boils down to this: Rates, currently at 2.5%, aren't likely to budge any time soon.
Smart money moves to make depending on what interest rates do
“As for whether rates are going to go up or down? Nobody knows for certain,” says Justin Halverson, a financial advisor at Minnesota-based Great Waters Financial.
While we’re in limbo, stick to your financial plan. Keeping up with saving, investing, and paying off debt will serve you well whether rates end up trending up or down.
As we get a sense of where interest rates are headed, here are some helpful strategies to consider.
While rates hold steady:
Pay down debt. Chipping away at your debt puts you in a better position to take advantage of eventual rate changes. If you’re debt-free, a rate hike will be much easier to manage.
Work on your credit score. Rates on some products—like auto loans, for example—are more dependent on your score than on the Fed’s changes. Taking steps to improve yours helps ensure you’re eligible for the best rates whenever you’re ready to buy.
As rates go down:
Think about big purchases. Falling rates makes it easier to snag a cheaper financing agreement if you’re looking at making a significant purchase like a home or a car.
Consider refinancing. If you have debt, lower rates could help you lock in a better deal.
As rates go up:
Save more. If you already have money in savings, you can shop around for accounts with higher rates. If the economy slows as a reaction to rising rates, you’ll be in a better position with some cash reserves, too.
Right now rates are ‘very low’
The Fed last increased rates in December 2018, and at the time, investors anticipated more increases were in the pipeline. In March, policymakers said they don’t expect further increases this year. Now, investors suspect the Fed could make its first rate cut since 2008. They’re betting there’s about a 28% chance of a rate cut by July, and an almost 80% chance by the end of 2019.
President Trump has nudged the Fed to reduce interest rates. “Our Federal Reserve has incessantly lifted interest rates, even though inflation is very low, and instituted a very big dose of quantitative tightening,” Trump tweeted in April. “We have the potential to go up like a rocket if we did some lowering of rates, like one point, and some quantitative easing.”
When people spend money, it creates demand. That leads to productivity and, usually, job creation. It makes sense, then, that the president would want to keep rates low.
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Why do some experts disagree? Because rates are already low: “Very low, from a historical perspective,” explains Michael Pearce, senior U.S. economist at Capital Economics in New York.
For context, the current federal funds rate is 2.5%. During the mid-2000s, it topped out at between 4% and 5%.
All the same, the economy has been sensitive to even those modest rate hikes over the past couple of years that got us to 2.5%. “They’re having a restraining impact on the economy,” Pearce says. For example, consumer confidence fell during the winter months, recovering only after the Fed decided to slow rate hikes in 2019.
“We saw it in the housing market,” he says, and “spending on new vehicles and household goods is now slowing.”
How interest rates affect the economy
The ability to set interest rates is one of the key tools that the Fed has at its disposal. The Fed’s goal is to keep inflation in check while also aiming for low unemployment. By tinkering with rates, the Fed has the ability to influence consumer behavior and the economy at large.
That’s because higher interest rates generally translate to higher rates on products like savings accounts and certificates of deposit (CDs), which gives you an incentive to save money.
When rates fall, it’s cheaper to borrow money, so people are more likely to spend—and spending juices the economy.
May 23, 2019