In their most recent meeting, the Fed increased interest rates once again. What does this mean and how does it impact you? We asked our Abacus Investment Committee to share their thoughts:
What is happening?
Yet again, the Fed raised the target range for the federal funds rate another 0.75% to a new range of 3.0% to 3.25%. The federal funds rate is the central bank’s benchmark borrowing rate, or the rate that banks lend to one another. This rate has a ripple effect across other rates in the market.
Why are they raising it again and how does it help with inflation?
The good news is that the economy is stronger than it was at the beginning of the pandemic, which has led to increased consumer confidence and spending. However, this has happened alongside supply-chain disruptions which have limited the supply of available goods to purchase, resulting in higher inflation.
Inflation remains well above the Fed’s target of 2% and getting inflation under control is crucial for a healthy economy. Many folks aren’t experiencing income increases in line with the rise in inflation, so the cost of goods they’re purchasing is outpacing the amount they’re making, which can significantly burden the average consumer.
This is where rate increases come in. When rates are low, it’s easier for consumers and companies to borrow and spend money. As rates increase, and borrowing gets more expensive, consumers and businesses are less inclined to spend. The Fed increases rates as a way to slow down the economy. As the economy slows down, inflation will eventually get back down to a healthier level. Higher interest rates also incentivize individuals to save more since they earn more for saving and investing at higher interest rates.
Should you be concerned?
We understand that volatility often feels uncomfortable, but ultimately we do not think this is cause for concern. This is part of a normal economic cycle and it makes sense that the Fed is stepping in to get inflation down. Since we’ve been in an artificially low interest rate environment for over a decade, it might seem unusual for rates to currently be where they are. For some perspective, the long-term average fed funds benchmark rate has actually been closer to 4.5%.
What does it mean for your investments?
Some headlines may lead you to worry that rising interest rates will negatively impact portfolio returns, particularly on the bond side. However, your Abacus portfolio and financial plan are constructed to incorporate short-term economic adjustments like this.
At Abacus, your bond portfolio is a well-diversified mix of shorter-term bonds relative to the market, which typically experiences less impact than longer-term bonds as rates rise.
While our portfolios aren’t immune to increasing rates, as long-term investors, you may actually benefit from higher interest rates. When you purchase a bond, you agree to receive a predetermined set of cash flows. While rising rates may push the short-term price of a bond down, they’re actually just pushing some of that return into the future because the terminal price at maturity (and therefore total return) is not affected. As rates rise, you also have the opportunity to invest the proceeds of bonds that mature in your portfolio into higher yielding bonds, setting you up for higher returns in the future.
When it comes to stocks, history offers good news. Following increases in the Fed funds rate, stock market returns in the US have been positive on average. Historically, there has also been no significant difference in performance for periods following a rate increase when compared to periods without rate increases.
Can we expect more hikes like this in the future?
Like most things in the financial world, it’s tough to know for sure. That said, it is likely rates will increase again. This is based on the Fed saying in a recent meeting that they anticipate ongoing increases in the target Fed funds rate range will be appropriate.
Is there anything I should do now?
While you may notice short-term volatility in your portfolio, the best course of action is sticking with the investment plan you agreed upon with your Abacus advisor. Your investment plan carefully incorporates shorter-term movements like this, as we expect them from time to time. If you have any further questions, reach out to your Abacus advisor today.