The Federal Reserve is expected to announce a rate hike soon. USA TODAY financial reporter Paul Davidson tells us what it could mean for the economy. USA TODAY
The Federal Reserve’s expected hike in its benchmark short-term interest rate this week — combined with rate increases the next few years — is likely to ripple across the U.S. economy, nudging up rates on everything from mortgages to bank savings rates and corporate bonds. But Fed policymakers have stressed they intend to move gradually and in small increments, and will pull back if the economy falters, tempering the impact on consumers and businesses.
The Fed is expected to boost rates only a quarter of a point Wednesday and move gradually after that. A 1 percentage point increase in the Fed’s rate over the next year could curtail economic growth the following year by 0.15 percentage points and monthly job gains by 30,000, according to Moody’s Analytics. Here’s how players in various sectors view the coming rate rise.
Perhaps no sector has benefited more from ultra-low rates than housing, which was devastated by the real estate crash. Home sales are expected to total about 5.7 million this year, up from 5.4 million in 2014 and 4.6 million in 2011. The recovery can at least partly be traced to 30-year fixed mortgage rates that remain below 4%, down from about 6% in 2008, keeping borrowing costs low for buyers.
But today’s housing market is supported by far more than low mortgage rates — namely steady job and economic growth. What’s more, 30-year mortgages are priced off 10-year Treasury note yields, which do rise as short-term rates climb, but not as steeply.
Doug Duncan, chief economist of Fannie Mae, the giant government-sponsored funder of mortgages, expects this week’s Fed hike of a quarter of a percentage point to have virtually no immediate impact on Treasury or mortgage rates, noting markets already have priced in the move. Assuming the Fed raises its rate by a percentage point over the next year, Duncan expects 30-year mortgage rates to drift from 3.9% to 4.1% during the period. That would boost the monthly cost of a typical $225,000 mortgage by $26 to $1,454 — not enough to deter most buyers.
Adjustable-rate mortgages, many of which are modified annually, could increase about twice as rapidly, by about a half a percentage point. Yet as long as job growth and aggregate U.S. incomes increase proportionally, Duncan expects any market impact to be modest. A far bigger restraint on home sales, he says, is a limited supply that should push up prices by nearly 5% both this year and in 2016. As a result, Duncan expects home sales to increase 4% in 2016, down from 8% this year, with higher rates holding back 1% to 2% of deals.
“As long as the rate rise is gradual, I don’t see it as a hugely important factor,” he says.
Auto sales are likely to top 17 million this year for the first time since the Great Recession, juicing the economy.
“(Low rates) definitely have been a factor in people’s buying decisions,” says Mark Scarpelli, president of Raymond Chevrolet and Kia, which owns three dealerships in the Antioch, Ill., area. Auto loans are cheap, with rates ranging from zero with manufacturers’ incentives to 3% or so for typical five-year loans, Scarpelli says.
But he says the improving economy and job market, low gasoline prices, and consumers’ need to replace aging vehicles are more significant. The typical car on the road is 11½ years old, a record high, according to IHS Automotive.
Scarpelli says his sales are up 25% this year. “Consumers are responding to the need to replace their car or truck,” he says.
A 1 percentage point increase in Fed rates the next year could have a similar impact on car loans, with a six-month lag, says Joe Pendergast, assistant vice president of consumer lending for Navy Federal Credit Union, a top auto lender. That, he says, would amount to an extra $16 or so for a typical loan on a $25,000 car.
“It’s not in our interest to start increasing rates,” he says.
Scarpelli says slightly higher rates “don’t seem to make people walk away from a deal. … It will have a measured impact,” largely by prodding some consumers to buy less expensive vehicles. He expects higher rates to trim sales by less than 1% in a year and up to 2% in two years.
Construction spending is up a healthy 10.7% this year as manufacturing, hotel and office building takes off. Slightly higher borrowing costs for projects is unlikely to alter that dynamic.
“If anything, a move by the Fed might provide a signal to nervous investors that the Fed is confident about the strength of the U.S. economy,” says Ken Simonson, chief economist of trade group Associated General Contractors. “Higher rates could also attract more foreign investors in all types of assets, including real estate.”
For manufacturers looking to expand for the fast-growing auto and aerospace sectors or office developers serving Millennials moving to cities, a small rise in borrowing costs will barely register, Simonson says. But the hotel- and warehouse-building craze may be winding down, he adds, and a modest rise in rates could discourage some activity in those industries.
The nation’s banks are among the few winners spawned by a Fed rate hike. Low rates have forced banks to make do with smaller margins between the interest rate they offer depositors and the rates they charge consumers and businesses for loans.
The most immediate impact of a Fed move will be on the credit cards and home equity loans offered by the nation’s largest banks. Those rates are variable and so should rise quickly in response to a higher fed-funds rate, which is what the Fed charges banks for overnight loans. In other words, banks will pass along their higher borrowing costs to consumers and businesses.
Currently, the average rate on credit card balances is 11.07%, says James Chessen, chief economist of the American Bankers Association. Weeks after the Fed raises its benchmark rate, that rate should rise by a similar amount.
Rates on deposits, however, are tied to market forces, he says. Currently, banks are flush with deposits from risk-averse consumers and businesses and so don’t need to lift savings rates immediately to attract more deposits for lending, he says.
Ronald Paul, CEO of EagleBank, with 22 branches in the Washington, D.C., area, says a rising fed-funds rate of about a percentage point in the next year will likely yield a similar increase in the rate Eagles charges businesses for new loans. Deposit rates could rise by a portion of that amount in about six months, he says, leaving the bank a fatter margin.
“If my competitor is raising rates, I have to compete,” he says. Overall, higher rates “certainly helps us, but it doesn’t radically help us.”
MONEY MARKET MUTUAL FUNDS
Money market funds are another beneficiary. The liquid funds invest in a mix of safe, short-term securities, such as Treasuries. But with yields well below 1%, investors have fled the assets in recent years. Total investment in the funds has fallen by nearly half since the 2007-09 recession, says John Carbone, principal and portfolio manager for The Vanguard Group.
“A lot of investors have moved out of money market funds” in an effort to “enhance their returns,” Carbone says.
That sharply reduces the fees money funds earn from investors. And with yields so low, most funds have waived the typical 0.6% fee they charge anyway to prevent shareholder returns from going negative, Carbone says.
Anticipation of a quarter-percentage-point increase in the Fed’s rate already has pushed up the prime money-market rate from 0.03% to 0.14% over the past six weeks, he says. “It will begin to enhance shareholder returns,” Carbone says. “We hope” it will boost his division’s revenue as well.
The markets expect the Federal Reserve to hike short-term interest rates for the first time in nearly a decade on Wednesday. That means higher interest rates on mortgages, credit cards and auto loans.
~ also see With Fed rate hike expected, 5 things to look for Wednesday from the AP ~