With another potential rate increase on October 28, here’s what you should know about CDs, money markets, bonds, mortgages and other financial decisions.
Whenever the Federal Reserve changes interest rates, one of the most common questions I hear from clients is: “How does this actually affect me?”
On September 16, the Fed raised its benchmark interest rate by 0.25 percentage points to a range of 3.75%–4.00%, its first increase in three years. With inflation remaining elevated, additional increases are possible. However, recent economic data and comments from Fed officials have introduced uncertainty about whether another increase will occur at the October 28 meeting.
Not all interest rates move together. Some financial products respond almost immediately to Fed decisions, while others are influenced by expectations about future economic conditions.
Understanding these differences can help you make more informed financial decisions. Let’s look at how these decisions affect your finances and what you should consider doing now.
- CDs: Should You Lock in Rates?
Certificates of Deposit (CDs) allow you to lock in a fixed interest rate for a specified period, making them attractive for investors seeking predictable income.
Although additional Fed increases could push some CD rates higher, banks also consider future interest rate expectations when setting their rates. Consequently, CD rates may change before the Fed’s next announcement.
What should you consider?
If you’re holding substantial cash reserves, consider whether locking in a portion at current rates makes sense.
A CD ladder, with deposits maturing at different intervals, can help balance competitive yields with access to your money over time.
We like brokered CDs – those CDs offered by brokerage firms like Vanguard, Fidelity and Schwab. They tend to offer much higher interest rates than can be found at a local bank and you can purchase them in your brokerage or retirement accounts easily with no fees.
Remember that traditional CDs generally impose early withdrawal penalties, and FDIC insurance is subject to applicable coverage limits.
- Money Markets: Attractive Yields, but for How Long?
Money market investments offer competitive yields while providing relatively easy access to your cash. Unlike CDs, their yields are variable and generally respond relatively quickly to changes in short-term interest rates.
If the Fed raises rates, money market yields may increase. However, when rates eventually decline, those attractive yields will fall.
It’s important to distinguish between bank money market accounts, which may qualify for FDIC insurance up to $250kpp, and brokerage offered money market mutual funds, which are investment products and are SIPC-insured for up to $500k.
What should you consider?
Money markets funds can be appropriate for emergency reserves and anticipated short-term expenses.
However, if you’re holding substantial amounts of cash that you won’t need for several years, consider whether allocating a portion to CDs or Treasury securities could provide more predictable income.
Today’s attractive money market yield isn’t guaranteed to last.
- Bonds and Treasuries: Understanding Interest Rate Risk
Bonds have an important relationship with interest rates: when market rates rise, existing fixed-rate bond prices generally fall. When rates decline, bond prices generally rise.
For example, suppose you own a bond paying 4%. If comparable newly issued bonds begin offering 5%, your existing bond becomes less attractive, and its market value typically declines.
However, not all bonds respond equally.
Short-term bonds generally experience smaller price fluctuations, while longer-term bonds are typically more sensitive to interest rate changes.
Although U.S. Treasury securities are backed by the federal government, their market values can still fluctuate.
Importantly, the Fed primarily influences short-term interest rates. Longer-term Treasury yields also reflect inflation expectations, economic growth and market conditions. Another Fed increase doesn’t automatically mean every Treasury yield will rise.
What should you consider?
Review your bond holdings, particularly their maturities and duration, to understand your exposure to interest rate changes.
Individual Treasury securities held to maturity generally return their principal and scheduled interest, subject to the government’s ability to pay. However, selling before maturity can result in a gain or loss.
Matching bond maturities with anticipated cash needs can help investors seeking predictable income.
- Mortgages and HELOCs: What Borrowers Should Know
Higher interest rates can increase borrowing costs, but the impact depends on your loan.
Home Equity Lines of Credit (HELOCs)
Most HELOCs have variable interest rates tied to the prime rate, which generally moves alongside the federal funds rate.
Another Fed increase could therefore translate relatively quickly into higher HELOC payments.
For example, a 0.25% increase on a $100,000 interest-only HELOC balance would add approximately $250 annually in interest expenses, or about $21 per month.
If you have a substantial HELOC balance, consider whether paying down principal or converting to a fixed-rate option makes financial sense.
New Fixed-Rate Mortgages
Unlike HELOCs, new fixed-rate mortgages are influenced primarily by longer-term bond markets, particularly the 10-year Treasury yield. Although Fed rate increases can push mortgage rates higher, the relationship isn’t automatic.
Mortgage rates may rise in anticipation of a Fed increase or even decline following an increase if inflation expectations improve. Prospective homebuyers should monitor mortgage rates rather than assume that waiting until after the next Fed meeting will result in better borrowing terms.
Adjustable-rate mortgages (ARMs)
If you have an ARM, review your upcoming adjustment dates, underlying index, margin and rate caps.
Understanding how your monthly payment could change is particularly important if your initial fixed-rate period is approaching its expiration date.
- Credit Cards, Auto Loans and the Stock Market
Credit cards typically carry variable interest rates, making them particularly sensitive to Fed decisions.
Another increase could make carrying credit card balances more expensive. New auto loans may also become costlier, although existing fixed-rate auto loans generally won’t be affected.
The stock market presents a different picture.
Higher borrowing costs can reduce corporate profitability, discourage expansion and pressure stock valuations. However, stock prices also reflect earnings, economic growth and expectations about future interest rates.
Because financial markets are forward-looking, anticipated Fed decisions may already be reflected in stock and bond prices.
For long-term investors, maintaining an appropriate asset allocation is generally more important than attempting to predict short-term market movements.
What Should You Do Before October 28?
The Fed’s next decision will depend on incoming inflation, employment and economic data. Whether rates increase or remain unchanged, its commentary about future monetary policy could influence financial markets.
Rather than trying to predict the outcome, consider these five financial planning strategies:
- Review your cash reserves. Compare savings and money market yields while maintaining sufficient liquidity for emergencies and anticipated expenses.
- Evaluate your CD strategy. Consider whether to lock in a portion of your cash at current rates or establishing a CD ladder makes sense.
- Review your fixed-income portfolio. Evaluate bond maturities, duration and credit quality to ensure your investments align with your financial goals.
- Examine variable-rate debt. Understand how additional rate increases could affect credit cards, HELOCs and adjustable-rate mortgages.
- Maintain a long-term perspective. Avoid making significant investment decisions based solely on predictions about the Fed’s next move.
The Bottom Line
Federal Reserve decisions affect far more than the interest rate on your savings account. They influence borrowing costs, investment returns, bond valuations and the broader economy.
However, different financial instruments respond differently, and markets frequently anticipate interest rate changes before they happen.
The key isn’t predicting exactly what the Fed will do on October 28. It’s understanding how changing interest rates affect your financial situation and making informed decisions accordingly.
If you have questions about how the current and pending rate change may affect your finances, you can schedule a strategy session to talk about your unique situation and how we might be able to help. If you are a current client, contact us for a personal review of your plan at info@astifinancial.com.