Brace yourselves, the Fed is about to cause ‘some pain’ to fight inflation – here’s how to prepare your wallet and yours
The Fed is willing to bring pain. are you ready?
Weeks ago, Federal Reserve Chairman Jerome Powell warned that there would be “some pain for households and businesses” as the central bank raises interest rates to combat inflation that is higher than it has been in four decades.
Powell and other members of the Federal Reserve’s Federal Open Market Committee matched Wall Street’s expectations on Wednesday of a 75 basis point hike in the federal funds rate, a repeat of previous Fed decisions in June and July. This increase will again affect credit card rates, auto loans, mortgages, and of course portfolio balances.
This brings the policy rate to a range of 3% to 3.25%. At this point last year, it was close to 0%. But the Fed is now beginning to raise an additional 125 basis points before the end of the year. “We will continue that until the job is done,” Powell said at a news conference following the announcement.
The average APR on a new credit card is now 18.10%, coming just a little closer to the 18.12% APR last seen in January 1996. Car loans are at 5% and mortgage rates are at 6% for the first time since 2008.
None of this is lost on Wall Street. Dow Jones Industrial Average
Down 15.5% YTD and S&P 500
It fell more than 19%, affected by multiple concerns, including a hawkish Federal Reserve. Volatile trade in the afternoon turned lower after the announcement and Powell’s comments.
Six out of 10 people say they are moderately or severely concerned about rising interest rates, according to a survey published Tuesday by the National Retirement Institute. More than two-thirds expect rates to rise, and possibly much higher, in the next six months.
Amit Sinha, managing director and head of multi-asset design at Voya Investment Management, asset management at Voya Financial, said the Fed is raising borrowing costs to curb demand and cool inflation.
“I think the Fed is going to have to cause pain if they want to maintain their credibility, which we think they will, and if they are really looking to get inflation under control,” Sinha said.
But experts advise people not to make the Fed’s decision lying around. Controlling debt, timing of major interest rate-sensitive purchases, and considering portfolio rebalancing can help ease financial pain.
Pay off debts as soon as possible
Americans had nearly $890 billion in credit card debt during the second quarter of 2022, according to the Federal Reserve Bank of New York. A new survey suggests that more people are holding onto their debt for longer — and with a higher APR making balancing more expensive, they are likely to pay more interest as a result.
Experts say the focus is on getting rid of high-interest debt. They noted that there are very few investment products that offer double-digit returns, so it pays to get rid of credit card balances with a double-digit APR.
This can be done, even with inflation above 8%, said financial advisor Susan Greenhalgh, president of Rhode Island-based Mind Your Money, LLC. Start writing down all your debts, break down principal and interest. Then aggregate all of your income and spending for a while, listing expenses from big to small, she said.
She said “eye contact” is critical. People may have a hunch about how they spend money, Greenhalgh said, but “until you see it in black and white, you don’t know.”
From there, people can see where they can cut costs. If swaps become difficult, Greenhalgh puts them back in what causes the most financial pain. “If debt is causing more pain than cutting or adjusting some spending, then you reduce or adjust in favor of paying off the debt,” she said.
Big purchases time carefully
Higher rates help discourage people from making big purchases. Look no further than the housing market.
But the financial twists and turns of life do not always align with the policies of the Federal Reserve. “You can’t pass the time when your kids go to college. You can’t pass the time when you need to go from place A to place B,” said Vuya Sinha.
It is a matter of classifying purchases into ‘wants’ and ‘needs’. Consultants say that people who decide they need to go ahead with a car or home purchase should remember that they can always refinance later.
If you decide to put off a major purchase, choose some threshold as your re-entry point. It can be interest rates or asking prices on a car or home that go down to a certain level.
Financial advisors say that while you wait, avoid returning any down payment money to the stock market. The volatility and the risk of loss outweigh the opportunity for short-term gains.
Safe and liquid havens such as a money market fund or even a savings account – which have increased annual returns due to higher prices – can be a safe place to stop money that will be ready to go if a buying opportunity arises.
Average APYs for online savings accounts jumped to 1.81% from 0.54% in May, according to Ken Tumin, founder and editor of DepositAccounts.com, while online one-year certificates of deposit (CDs) rose to 2.67% from 1.01% in May.
Read also: Opinion: Surprise! CDs are back in vogue with Treasurys and I-bonds as a safe haven for your money
Portfolio rebalancing for tough times
Sinha said the investment standard rules still apply: Long-term investors with at least a 10-year timeline must remain fully invested. The havoc in stocks now may represent deals that will pay off later, he said, but that people should consider increasing their exposure to fixed income, at least in line with their risk tolerance.
This could start with government bonds. “We are in an environment where you are paid to be a saver,” he said. This is reflected in higher yields on savings accounts and also in one-year Treasury yields
and 2 year notes
He said. Both yields are hovering at 4%, up from nearly 0% a year ago. So feel free to count on that, he said.
As interest rates rise, bond prices usually fall. Short-term bonds, with less chance of interest rates depleting market value, have appeal, said Gargi Chaudhry of BlackRock. “The short end of the curve for investment-grade corporate bonds remains attractive,” Chaudhry, president of iShares Investment Strategy Americas, said in a note Tuesday.
“We remain more cautious about long-term bonds because we feel that interest rates can remain at their current levels for some time or even rise,” Chaudhry said. “We urge patience as we believe we will see more attractive levels of long-term entry in the next few months.”
For stocks, think of stable, high quality at the moment, such as the healthcare and pharmaceutical sectors.
Whatever the combination of stocks and bonds, make sure it’s not a mixture of unwillingness to mingle, said Eric Cooper, financial planner at Commonwealth Financial Group.
Any rebalancing, he said, must be based on well-researched strategies and must fit a person’s stomach for risk and reward, both now and in the future. And remember, the current stock market pain may pay off later. In the end, Cooper said, what’s saving you? [in the long term] It’s what crushes you now.”