Mellody Hobson 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.
Tom: We are talking interest rates today?
Mellody: We are! Interest rates can have a big impact on people, all across their financial life – from your stock portfolio to your mortgage payments. Because of this, this morning, i want to walk our listeners through a few of the things they should think about before interest rates rise, and what is driving the rate rise in the first place.
Tom: can we start with why the fed might push interest rates higher?
Mellody: Absolutely. As you may have heard last week, the jobs report was strong again in June – the economy created 288,000 jobs – and the unemployment rate is the lowest it has been since September 2008. Additionally, the April jobs numbers were revised upwards to 304,000, a number that represents the strongest gain since January of 2012. These figures suggest that the GDP contraction from the first quarter was an outlier, the result of a perfect storm of weather, high inventories, and consumers closing their pocket books after the holidays. Combine all of these positive indicators together, and you start to see positive momentum. The news has driven the stock market higher – the down closed over 17,000 during on Thursday – but it has also caused the fed to closely watch inflation and the money supply. In order to prevent bubbles, such as the housing bubble that led to the recession, the fed is likely to raise rates at some point next year.
Tom: Anything else we should know?
Mellody: If rates are rising for the right reasons, however, the impacts to your portfolio may not be negative. This could very well be the case in this environment, where we are seeing a strengthening economy, an improving labor market with job creation, and higher demand for credit, all while the regulatory oversight for the financial sector is getting stronger. 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.
Tom: Where else are we going to see an impact?
Melody: another place that rate hikes tend to hit people is housing. If you are in the market to buy a house, rising interest rates are going to 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.
If you or your kids will be taking out student loans, a rate hike will likely drive the cost of those loans lower, because of the inverse relationship between interest rates and treasury yields. Due to the fact that the interest rate on student loans is linked to the 10 year Treasury note, an improving economy and higher interest rates are likely to make your loans cheaper over the long run. However, as you know, try to avoid those loans as much as possible.
Finally, interest rates generally have an inverse relationship with inflation. Therefore, with higher interest rates and monetary policy becoming tighter, it is likely that consumer’s will not see the prices of goods rise as fast as they currently do now.
Tom: Ok! When should we expect to see higher rates?
Mellody: That’s a great question. Fed chairwoman Yellen has said that she does not see a need for rate hikes in the immediate future, but the improving economic news could change that. There is a lot of speculation out there, but the consensus seems to be that we will see interest rates rise by this time in 2015, if not a bit earlier. So, there is still some time left, if you want to buy a house or talk to your financial advisor about what approach you should take!