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Tom: You are joining us this morning to talk about the recent Fed decision on interest rates, is that right?
Mellody: That’s right, Tom Joyner. The current short-term interest rate is still near zero after this past federal open markets committee meeting, keeping it where it has been for nearly seven years since the great recession. This morning, I want to talk about why the Fed decided to go this route, and what consumers can expect in the coming months!
Tom: Why had analysts expected a raise for most of this year?
Mellody: The Fed had been telegraphing an expected rate raise for almost a year based on the improving American economy. A number of indicators that the Fed looks at have all been pointing in the right direction, with consistent positive trends across the board. The unemployment rate has been dropping consistently, hitting 5.1% in august, the lowest rate since april of 2008, over seven years ago. The economic growth rate in the past few quarters has exceeded expectations. Consumer confidence was high throughout the summer. All of these indicators had been encouraging to the FOMC, and led to the expectation they would move in September.
Tom: What made them change their mind?
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Mellody: It may sound like it doesn’t make sense, but the reasons they hit the brakes had very little to do with factors within the United States, and almost everything to do with concerns about economic growth abroad. As chairwoman Yellen put it, the Fed saw “heightened concerns abroad.” And what she was talking about was China, which had been the main engine of global economic growth in the past few years. The Chinese economy has seen a fairly dramatic slowdown, and the country’s stock market has caused global market jitters. On top of that, European growth was underwhelming for most of the year, and emerging markets outside of China have struggled as well. As a result, the Fed decided to postpone raising interest rates.
Tom: Can we expect a rate change in the near future?
Mellody: I believe so. The Fed has said it expects to continue to move toward raising rates because it believes economic growth in the U.S. will continue, which will further push the unemployment rate down, drive slow but steady wage growth and eventually raise inflation to target levels. In a speech last week after the Fed decision, chairwoman Yellen reaffirmed these beliefs. Some analysts expect that could happen as soon as October, but most feel confident that it will happen before the end of 2015.
Tom: What will that mean for consumers?
Mellody: There are so many places people will feel a rate hike! First: your investment portfolio. In a period of rising interest rates, if you have significant investments in bonds, you will likely take a hit, because interest rate hikes will eat away at those returns. However, if rates are rising for the right reasons, the impacts to your portfolio may not be negative. This could very well be the case right now, as we are a growing economy, and an improving labor market with job creation. In this environment, high yield bonds and floating rate bonds can do well. The same is true for stocks. Stocks don’t have to decline in a higher-rate environment as long as the rate hikes are coming due to stronger economic numbers. A number of times we have seen the stock market rise along with rates if the economic fundamentals are improving or strong.
However, borrowing money will get more expensive. If you are thinking about buying a house, an interest rate hike will make it more expensive to borrow that money. For example, if you borrowed $165,000 over 30 years at 3.25%, you would pay just over $92,000 in interest over the life of that loan. If you borrowed the same amount at 4%, you would pay nearly $118,000. That is $28,000 that could have been saved and invested, which is significant. The same is true for other borrowing, such as auto loans or student loans. Overall, an interest rate rise signals a stronger economy, but there will be some drawbacks for consumers.
Tom: Always good to have you explain things to us! Thanks for joining us, Mellody!
Mellody: Great to be here, Tom!
Mellody is President of Ariel investments, a Chicago-based money management firm that serves individual investors and retirement plans through its no-load mutual funds and separate accounts. Additionally, she is a regular financial contributor and analyst for CBS News.
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