What the PauseIn Rising RatesMeans for You
Fed's Inaction Could Be a BoonFor Homeowners, Borrowers;Time to Consider Longer-Term CDs
By JEFF D. OPDYKE, JENNIFER SARANOW and RUTH SIMON
Fed's Inaction Could Be a BoonFor Homeowners, Borrowers;Time to Consider Longer-Term CDs
By JEFF D. OPDYKE, JENNIFER SARANOW and RUTH SIMON
August 9, 2006
Finally, it's over -- for now.
For the first time since June 2004, the Federal Reserve yesterday left short-term interest rates unchanged. Though the Fed could resume its cycle of interest-rate increases -- and some market observers think the Fed will do so one or two more times to ward off any threat of inflation -- the decision to pause at 5.25% will ripple through the pocketbooks and portfolios of investors and consumers, affecting everything from stock and bond investments to home-equity loans.
In its brief announcement yesterday afternoon explaining the decision to stop raising rates after 17 consecutive increases, the Fed said it halted the rate increases because economic growth is moderating, thanks to the impact of a softening housing market, high energy prices and previous rate increases. The Fed also noted that while some inflation risk remains, inflation pressure "seems likely to moderate over time."
Wall Street had been anticipating the Fed's action, and much of that expectation was already factored into stocks and bonds, both of which have rallied in recent weeks. After the announcement, the Dow Jones Industrial Average fell, finishing down 45.79 points at 11173.59, while the yield on 10-year bonds rose slightly.
While a pause doesn't have the same effect on consumer finances and investments as a rate cut or a rate increase, the move, after such an extended string of increases, is expected to make a noticeable impact.
Here's how the pause could affect small investors and consumers:
Homeowners. The Fed's move is likely to provide some much-needed relief for home buyers and for borrowers with adjustable-rate mortgages and home-equity lines of credit.
Home buyers "who are looking at longer-term fixed-rate products are going to get a pretty good deal," says Doug Duncan, chief economist of the Mortgage Bankers Association. Mr. Duncan believes that rates on fixed-rate mortgages aren't likely to move much higher unless the Federal Reserve decides to boost rates again to stem inflationary pressures. The pause will also slow the pace at which rate increases are being passed on to borrowers with adjustable-rate mortgages, though some borrowers could see their rates continue to rise if their payments are tied to an index such as the 12-month Moving Treasury Average, which reflects rate moves on a lagging basis.
Even before yesterday's move, rates on 30-year fixed-rate mortgages had begun edging downward, driven both by anticipation that the Fed would take a breather and by competition for customers amid falling mortgage volume. Yesterday, they stood at 6.66%, nearly one-third of a percentage point below their recent peak of nearly 7%, according to HSH Associates, financial publishers in Pompton Plains, N.J.
Borrowers, however, shouldn't expect too much rate relief, even if they are willing to take on an adjustable-rate mortgage. Rates on so-called five-one hybrids -- mortgages that carry a fixed-rate for the first five years then adjust annually -- currently average 6.43%, less than a quarter of a percentage point below the rate on a 30-year fixed-rate mortgage, according to HSH. For home buyers who can afford the higher payments, "a fixed-rate probably makes sense...because it eliminates the possibility of higher rates down the road," says Keith Gumbinger, a mortgage analyst at HSH.
The pause is likely to be particularly welcomed by borrowers who have taken out home-equity lines of credit, which are typically tied to the prime rate. Rates on home-equity lines currently average 8.74%, up from 4.68% before the Federal Reserve began its campaign to raise rates, according to HSH. That compares with an average rate of 8.14% for fixed-rate home-equity loans.
Shoppers. Two-thirds of all Americans own credit cards with variable interest rates. That rate is typically tied to the prime rate, and during the Federal Reserve's rate-raising campaign, the prime rate jumped to its current 8.25% from 4.25%. In turn, shoppers who whip out the plastic for their purchases have watched their annual interest rates climb to 19% on average from 15.4% two years ago, according to the Nilson Report, a payment-card-industry newsletter.
The Fed's pause doesn't mean your credit-card rate is headed lower. While mortgage rates are based on bond-market yields, which are highly fluid and ever-changing, credit cards are tied to the prime, which only moves when the Fed changes interest rates.
Still, for shoppers who routinely carry a balance on their credit cards, a pause is a reprieve from higher monthly payments. Don't be complacent, though, warns David Robertson, publisher of the Nilson Report. Credit-card companies routinely revise the terms of agreement under which they provide you credit. In doing so, many may still decide to raise the interest rate you pay. They must first warn you of the rate increase, so pay attention to the paperwork that lands in your mailbox and which many people regularly throw away.
Savers. For the first time in several years, people holding short-term certificates of deposit might have reason to finally lock in some longer-term CDs. The reason: The pause, as well as the relatively dovish language the Fed used to describe inflation, "makes you scratch your head and think that maybe 5.8% locked in for three to five years is a good bet," since it seems rate increases are likely near an end, says Bankrate.com's Greg McBride.
Money-market mutual funds likely do have a bit of upside left in them, since interest-rate increases typically take five to seven weeks to filter down, and the last increase in July is still working through the system. Savers so far this year have put nearly $89 billion into such funds, the largest movement in this arena since early 2002, according to iMoneyNet.com, a provider of money-market mutual-fund data. The best performing money-market fund, Transamerica's Premiere Cash Reserve fund, currently yields an annualized 5.13%.
Drivers. The Fed's decision isn't likely to have much effect on auto-loan rates, analysts say. In fact, rising interest rates haven't had much of an impact on auto-loan rates in general, thanks to competition among banks, car-maker financing arms and credit unions amid a continuing effort to boost sluggish car sales. The average rate for a five-year car loan, according to Bankrate.com, is now 7.98% -- up marginally from 7.45% when the Fed launched its rate-tightening cycle in 2004.
Once the Fed begins lowering rates, which many expect to happen next spring, car buyers will see better financing opportunities, lower rates and more lenient qualifying criteria for purchased vehicles. In recent years, car makers and their financing arms have focused more on lease incentives than financing deals and have raised the qualifying criteria for the discounted financing rates they do offer.
Some market watchers say more widespread financing deals could even start happening as soon as the Federal Reserve backs away from raising interest rates two or three times. "If rates stay the same, there's a little more comfort room for offering discounted financing," says Art Spinella, president of automotive-market research firm CNW Marketing Research Inc.
Investors. The Fed's decision to pause gives investors reason to lock in longer-term bonds.
For the past couple of years, bond investors -- as a way to keep their money relatively liquid in a rising-rate environment -- have been focused largely on short-term bonds that mature in two to three years. Now, however, as the Fed talks of a slowing economy, "you want to start thinking about extending the duration" of the bonds in your portfolio, says Marilyn Cohen, president of Envision Capital Management, a bond-investment firm in Los Angeles. That means locking in some longer-term bonds before interest rates start backsliding. Stick to high-grade corporate and municipal bonds that mature in seven to nine years -- so-called intermediate-term bonds.
The stock market, by contrast, is beginning to focus more on macroeconomic issues, such as the potential for a slowing economy, and less on the Fed's short-term decisions. Investors, for instance, have been exiting from economy-sensitive industries such as home builders, transportation and some commodity sectors, and are focusing these days more on companies that can weather a slowdown: brewers, soft-drink companies, drug makers and health-care providers.
Charles Schwab & Co. has been urging its clients to become increasingly defensive this year by increasing their allocation to cash, among other things. John Lynch, chief market analyst at Evergreen Investments, a Boston asset-management firm, says investors should be looking more to large-company stocks instead of the small- and midsize stocks that have fared so well in recent years.
Investors should now be "looking for predictability and stability of companies," says David Darst, chief investment strategist for Morgan Stanley's global wealth-management group. Morgan Stanley, Mr. Darst says, has been telling clients to "take money off the table" in areas such as coal and trucking and to look to companies that will retain pricing power and growth even in a slowdown -- such as those in medical supplies and utilities.
Investors and economists generally foresee a weakening dollar. Though U.S. interest rates are still higher than those in Europe and Asia, that could be a temporary situation. While the Federal Reserve has declined, for now, to raise rates, central bankers elsewhere are expected to continue raising rates, which will pull investors out of the dollar and into foreign currencies.
A weakening dollar will benefit foreign assets, including stocks, bonds and real estate. As the dollar slips, such investments are worth more as their value grows in dollar terms.
Finally, it's over -- for now.
For the first time since June 2004, the Federal Reserve yesterday left short-term interest rates unchanged. Though the Fed could resume its cycle of interest-rate increases -- and some market observers think the Fed will do so one or two more times to ward off any threat of inflation -- the decision to pause at 5.25% will ripple through the pocketbooks and portfolios of investors and consumers, affecting everything from stock and bond investments to home-equity loans.
In its brief announcement yesterday afternoon explaining the decision to stop raising rates after 17 consecutive increases, the Fed said it halted the rate increases because economic growth is moderating, thanks to the impact of a softening housing market, high energy prices and previous rate increases. The Fed also noted that while some inflation risk remains, inflation pressure "seems likely to moderate over time."
Wall Street had been anticipating the Fed's action, and much of that expectation was already factored into stocks and bonds, both of which have rallied in recent weeks. After the announcement, the Dow Jones Industrial Average fell, finishing down 45.79 points at 11173.59, while the yield on 10-year bonds rose slightly.
While a pause doesn't have the same effect on consumer finances and investments as a rate cut or a rate increase, the move, after such an extended string of increases, is expected to make a noticeable impact.
Here's how the pause could affect small investors and consumers:
Homeowners. The Fed's move is likely to provide some much-needed relief for home buyers and for borrowers with adjustable-rate mortgages and home-equity lines of credit.
Home buyers "who are looking at longer-term fixed-rate products are going to get a pretty good deal," says Doug Duncan, chief economist of the Mortgage Bankers Association. Mr. Duncan believes that rates on fixed-rate mortgages aren't likely to move much higher unless the Federal Reserve decides to boost rates again to stem inflationary pressures. The pause will also slow the pace at which rate increases are being passed on to borrowers with adjustable-rate mortgages, though some borrowers could see their rates continue to rise if their payments are tied to an index such as the 12-month Moving Treasury Average, which reflects rate moves on a lagging basis.
Even before yesterday's move, rates on 30-year fixed-rate mortgages had begun edging downward, driven both by anticipation that the Fed would take a breather and by competition for customers amid falling mortgage volume. Yesterday, they stood at 6.66%, nearly one-third of a percentage point below their recent peak of nearly 7%, according to HSH Associates, financial publishers in Pompton Plains, N.J.
Borrowers, however, shouldn't expect too much rate relief, even if they are willing to take on an adjustable-rate mortgage. Rates on so-called five-one hybrids -- mortgages that carry a fixed-rate for the first five years then adjust annually -- currently average 6.43%, less than a quarter of a percentage point below the rate on a 30-year fixed-rate mortgage, according to HSH. For home buyers who can afford the higher payments, "a fixed-rate probably makes sense...because it eliminates the possibility of higher rates down the road," says Keith Gumbinger, a mortgage analyst at HSH.
The pause is likely to be particularly welcomed by borrowers who have taken out home-equity lines of credit, which are typically tied to the prime rate. Rates on home-equity lines currently average 8.74%, up from 4.68% before the Federal Reserve began its campaign to raise rates, according to HSH. That compares with an average rate of 8.14% for fixed-rate home-equity loans.
Shoppers. Two-thirds of all Americans own credit cards with variable interest rates. That rate is typically tied to the prime rate, and during the Federal Reserve's rate-raising campaign, the prime rate jumped to its current 8.25% from 4.25%. In turn, shoppers who whip out the plastic for their purchases have watched their annual interest rates climb to 19% on average from 15.4% two years ago, according to the Nilson Report, a payment-card-industry newsletter.
The Fed's pause doesn't mean your credit-card rate is headed lower. While mortgage rates are based on bond-market yields, which are highly fluid and ever-changing, credit cards are tied to the prime, which only moves when the Fed changes interest rates.
Still, for shoppers who routinely carry a balance on their credit cards, a pause is a reprieve from higher monthly payments. Don't be complacent, though, warns David Robertson, publisher of the Nilson Report. Credit-card companies routinely revise the terms of agreement under which they provide you credit. In doing so, many may still decide to raise the interest rate you pay. They must first warn you of the rate increase, so pay attention to the paperwork that lands in your mailbox and which many people regularly throw away.
Savers. For the first time in several years, people holding short-term certificates of deposit might have reason to finally lock in some longer-term CDs. The reason: The pause, as well as the relatively dovish language the Fed used to describe inflation, "makes you scratch your head and think that maybe 5.8% locked in for three to five years is a good bet," since it seems rate increases are likely near an end, says Bankrate.com's Greg McBride.
Money-market mutual funds likely do have a bit of upside left in them, since interest-rate increases typically take five to seven weeks to filter down, and the last increase in July is still working through the system. Savers so far this year have put nearly $89 billion into such funds, the largest movement in this arena since early 2002, according to iMoneyNet.com, a provider of money-market mutual-fund data. The best performing money-market fund, Transamerica's Premiere Cash Reserve fund, currently yields an annualized 5.13%.
Drivers. The Fed's decision isn't likely to have much effect on auto-loan rates, analysts say. In fact, rising interest rates haven't had much of an impact on auto-loan rates in general, thanks to competition among banks, car-maker financing arms and credit unions amid a continuing effort to boost sluggish car sales. The average rate for a five-year car loan, according to Bankrate.com, is now 7.98% -- up marginally from 7.45% when the Fed launched its rate-tightening cycle in 2004.
Once the Fed begins lowering rates, which many expect to happen next spring, car buyers will see better financing opportunities, lower rates and more lenient qualifying criteria for purchased vehicles. In recent years, car makers and their financing arms have focused more on lease incentives than financing deals and have raised the qualifying criteria for the discounted financing rates they do offer.
Some market watchers say more widespread financing deals could even start happening as soon as the Federal Reserve backs away from raising interest rates two or three times. "If rates stay the same, there's a little more comfort room for offering discounted financing," says Art Spinella, president of automotive-market research firm CNW Marketing Research Inc.
Investors. The Fed's decision to pause gives investors reason to lock in longer-term bonds.
For the past couple of years, bond investors -- as a way to keep their money relatively liquid in a rising-rate environment -- have been focused largely on short-term bonds that mature in two to three years. Now, however, as the Fed talks of a slowing economy, "you want to start thinking about extending the duration" of the bonds in your portfolio, says Marilyn Cohen, president of Envision Capital Management, a bond-investment firm in Los Angeles. That means locking in some longer-term bonds before interest rates start backsliding. Stick to high-grade corporate and municipal bonds that mature in seven to nine years -- so-called intermediate-term bonds.
The stock market, by contrast, is beginning to focus more on macroeconomic issues, such as the potential for a slowing economy, and less on the Fed's short-term decisions. Investors, for instance, have been exiting from economy-sensitive industries such as home builders, transportation and some commodity sectors, and are focusing these days more on companies that can weather a slowdown: brewers, soft-drink companies, drug makers and health-care providers.
Charles Schwab & Co. has been urging its clients to become increasingly defensive this year by increasing their allocation to cash, among other things. John Lynch, chief market analyst at Evergreen Investments, a Boston asset-management firm, says investors should be looking more to large-company stocks instead of the small- and midsize stocks that have fared so well in recent years.
Investors should now be "looking for predictability and stability of companies," says David Darst, chief investment strategist for Morgan Stanley's global wealth-management group. Morgan Stanley, Mr. Darst says, has been telling clients to "take money off the table" in areas such as coal and trucking and to look to companies that will retain pricing power and growth even in a slowdown -- such as those in medical supplies and utilities.
Investors and economists generally foresee a weakening dollar. Though U.S. interest rates are still higher than those in Europe and Asia, that could be a temporary situation. While the Federal Reserve has declined, for now, to raise rates, central bankers elsewhere are expected to continue raising rates, which will pull investors out of the dollar and into foreign currencies.
A weakening dollar will benefit foreign assets, including stocks, bonds and real estate. As the dollar slips, such investments are worth more as their value grows in dollar terms.
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