The Federal Reserve raises or lowers the Fed funds rate in order to either increase or slow down the rate of growth in the U.S. economy. The Fed funds rate is the rate member banks charge each other for the use of excess reserves. This rate trickles down to what banks then charge for loans such as car loans, mortgages, credit cards, business loans and other financial transactions.
Although the Federal Reserve may not want to slow the economy in this instance, they apparently feel the need to move away from the emergency, zero interest rate policy (ZIRP) put into place during the “Great Recession.” Too much free money in the system could cause inflationary pressures in the economy, eventually leading to another recession if some of this money is not removed from the system. The Fed realizes this, and is attempting to start the process of removing some of the money that has flooded the financial system over the last nine years.
What does this mean for me?
As previously mentioned, your cost of borrowing will increase with any rise in rates. Remember, though, that interest rates remain very low historically. The cost of money is still very favorable. On the other side of the ledger, you will be able to receive higher returns on your fixed income investments. Money Market accounts, CD’s, Corporate and Municipal securities all will eventually yield a higher return as the general “cost” of finance rises.
What has Fort Pitt been doing to prepare for this?
Fort Pitt has been anticipating this rate rise, and adjusting our portfolios accordingly. In the individual bond accounts, we have been building short-term, laddered portfolios which achieve a reasonable yield during ZIRP, but also give us the flexibility to reinvest maturing bonds at higher rates when they come due. On the asset allocation side of fixed income, we reallocated assets away from some longer duration funds to others with shorter duration and higher credit quality. This removes some of the risk of higher interest rates. We will continue this policy, as the Fed appears to be just getting started in normalizing interest rates.
If you have any questions regarding today’s announcement, please do not hesitate to reach out to your advisor.