Preparing for Liftoff after the Long Wait
I often call my mother when I drive to work in the morning. Invariably, the conversation turns to what she’s been reading in the newspapers or watching on TV—and, years ago, my career choice inspired her to pay attention to financial news. These days, it usually doesn’t take long before she asks me when the Fed is going to raise interest rates, by how much, and what she should do in response.
Of course, it’s not just my mom. All investors are in some way focused on interest rates and what the Federal Reserve will do because rates have a way of rippling through the economy in multiple ways and directions. Investors, and particularly savers and borrowers, have a stake in what happens next.
Early in my career, I worked at the Federal Reserve Bank of New York as an economist and I’ve watched the central bank very closely ever since. One big takeaway from my years of observation is that investors tend to get hurt when the Fed does the unexpected. The most disruptive monetary policy is one filled with surprises, in terms of timing, magnitude, or both.
By contrast, the risk of surprise from the Fed today seems very low. Welcome to the most-anticipated, most talked-about rate increase anyone who has followed the market can recall. Historically, the Fed has been known for obfuscation; central bankers said little out of fear of tipping their hand. This time, though, the Fed has been unusually transparent.
Our central bank has kept its benchmark federal-funds rate pinned near zero since December 2008, first to help the U.S. economy weather the global financial crisis and the ensuing recession, and later, to sustain it through a protracted, lackluster recovery. To find the last time the Fed raised rates, you need to go all the way back to June 2006. Back then, George W. Bush was President; the Dow Jones Industrial Average was trying to top 11,000; and a stamp cost 39 cents. At that time, the Fed was raising rates for the 17th consecutive time in just under two years, bringing the fed funds rate all the way up to 5.25%. It took the Fed a little more than two years to drop the rate to its present range of 0% to 0.25%.
In speeches, testimonies and other pronouncements, Fed officials have let us know that they’d raise rates only when they were confident the economy was back on its feet and the markets could absorb such moves. Fed officials also let us know what indicators they have been watching (unemployment, for one), and why they balked at raising rates in recent meetings.
"We may not know exactly when, but there is a strong degree of certainty in the market that the Fed will raise rates soon, and December seems increasingly likely."
We may not know exactly when, but there is a strong degree of certainty in the market that the Fed will raise rates soon, and December seems increasingly likely. I think there’s also a pretty strong sense that once the Fed raises rates, it likely will be the start of a series of gradual and protracted increases. Nothing too dramatic or too soon. I don’t believe that the Fed is trying to shock the market, and provided it moves rates up slowly and steadily, communicating its intentions along the way, I expect investors to take all these moves in stride.
When people talk about rising interest rates, they sometimes don’t distinguish which rates – short- or long-term. The Fed is focused on short term borrowing rates. When the Fed raises rates, these are the interest rates that are going to be most impacted. That means investors likely will see an increase on the yield on their cash savings and very short-term bonds. The reality is, given that the Fed has been so clear about their intentions, these rates have already been moving up in anticipation of Fed action. As a result, when the Fed actually makes their announcement, I believe it’s unlikely there will be any dramatic changes to these levels of interest rates.
Long-term rates are driven more by expectations about inflation and economic growth, rather than what the Fed does. And, by most measures, inflation is tame and expected to remain so. So any Fed moves likely won’t influence rates on long-term bonds in the near term.
My thoughts for investors are the same that I express to my mom: Now isn’t the time to make any drastic portfolio changes simply in response to what interest rates might or might not do. Rather than focus too much on the here and now of the Fed policy decision, spend a little extra time with your loved ones, check out that holiday movie you’ve wanted to see, or plan your spring vacation. The great Fed debate will be here when you get back.
President and CEO, Charles Schwab Investment ManagementDownload this article Print
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About the author
Marie Chandoha is President and Chief Executive Officer of Charles Schwab Investment Management Inc. (CSIM), a subsidiary of The Charles Schwab Corporation. Chandoha is an Executive Vice President of Schwab and serves on the corporation’s Executive Council. With more than $265 billion under management, CSIM is one of the nation’s largest asset management companies, the third largest provider of index funds and a top 10 provider of ETFs and money market funds.* Since assuming leadership of CSIM in 2010, Chandoha has achieved record growth by developing a cultural commitment to providing investors with quality funds at a great value, managing them with integrity and examining risk from multiple angles. A passionate advocate for the interests of investors and the advancement of women in financial professions, Chandoha is considered one of the most accomplished and respected female executives in the industry. She was recently named one of the top women in asset management by Money Management Executive and one of the most powerful women in finance by American Banker.
*As of September 30, 2015.
The opinions expressed are not intended to serve as investment advice, a recommendation, offer, or solicitation to buy or sell any securities, or recommendation regarding specific investment strategies. Information and data provided have been obtained from sources deemed reliable, but are not guaranteed. Charles Schwab Investment Management makes no representation about the accuracy of the information contained herein, or its appropriateness for any given situation.
Some of the statements in this document may be forward looking and contain certain risks and uncertainties.
The views expressed are those of Marie Chandoha and are subject to change without notice based on economic, market, and other conditions. Past performance is no guarantee of future results.