The Real Story Behind “Rising” Interest Rates
This year, the Federal Reserve has hiked its target interest rate twice… With a third rate hike expected before the end of the year.
Great news for savers right? Because higher interest rates will allow us to collect more income from deposits at the bank. Isn’t that how it works?
Well unfortunately, that’s not at all what we’re seeing in the market right now. And I don’t think savers will have any reason to cheer about higher interest rates for months and months to come.
Here’s the real story behind the Fed’s rate hikes and the interest rates you’ll have to work with at the bank…
The Fed’s Target Rate
Take a look at the chart below. This chart shows the yield (or interest rate) on 10-year treasury bonds for 2017:
Can you pick out the two spots where the Fed hiked interest rates this year?
Neither can I!
That’s because the Fed’s two interest rate hikes had essentially ZERO effect on the 10-year treasury yield. Instead, the interest rate on treasury bonds has been moving lower throughout the year — not higher.
It’s important to realize that yields on Treasury bonds have a much bigger impact on the interest rates that will affect your life than any rate that Janet Yellen and the Fed can set.
When banks decide what rate of interest to charge customers for mortgages or business loans, or when these same banks set interest rates for savings accounts or certificates of deposits, they base their decisions primarily on Treasury bond yields.
That’s because the Treasury bond market is a very liquid market in which investors buy and sell bonds based on the yield that they can receive from owning these bonds, and competing investments they can make with the same capital.
Essentially, Treasury bond prices represent free market interest rates, as opposed to manipulated interest rates set by the Fed. Keep in mind, the target interest rate that the Fed sets is simply the rate the Fed targets for when banks lend short-term deposits to each other.
This rate is only very loosely connected to market interest rates (which we can see have been falling).
So when you hear that the Fed is raising interest rates, just keep in mind that an increase in the Fed’s target rate doesn’t necessarily mean that you’ll get a higher return on your savings account (or that you’ll have to pay a higher rate for a mortgage)…
What To Expect For The Rest of The Year
This week, the Fed released its minutes from the most recent Fed meeting.
According to the notes, the Fed is deeply divided between raising rates one more time this year and keeping them steady.
Some members believe that the Fed’s policy of exceptionally low rates will backfire, leaving the Fed fewer options for helping the economy during the next recession. While others believe that the global market has changed, and that lower interest rates are now much more appropriate.
Here’s what you can expect from the Fed for the rest of this year…
Janet Yellen and her colleagues are very unlikely to raise their target rate. So far, they’ve seen that raising their target rate has very little effect on real market rates.
More importantly, the Fed understands that the majority of U.S. citizens (and corporations) are carrying a significant amount of debt. If rates remain low, consumers can continue to run up credit card balances, borrow money against their homes, and spend that money. In the Fed’s mind, this is a good thing, because it keeps the economy humming along.
The danger of raising target rates too much is that it could affect the Treasury bond market and stall our current economic rebound. At this point, our recovery is still vulnerable and higher interest rates could cause companies to quit hiring, which would cause consumers to stop spending — thus triggering a new recession.
So as long as the U.S. economy continues to be in “weak recovery” mode, I expect the Fed’s target rate — along with market interest rates — to remain low.
That’s bad news for you if you’re hoping to get a higher rate on your deposit at the bank.
But thankfully, we don’t need high interest rates to earn a livable income.
That’s because you can invest in solid dividend-paying companies to earn a steady stream of income. These dividends are much like coupon payments from treasuries, without the downside risks related to Janet Yellen and the Fed.
So while it’s safe to still keep money allocated into a traditional savings account, I also recommend allocating savings into a few specific dividend paying companies.
Here are a few dividend paying companies that I recommend today:
Apple (NASDAQ:AAPL)– Even while trading at all-time highs, I feel Apple has much farther to go. The company is literally sitting on billions in cash, and right now the company pays $2.52 per share in dividends per year. I expect this yield to increase once Apple brings its massive overseas cash hoard back to the states.
Procter & Gamble (NYSE:PG)– From dish soap to razors to toilet paper — you name it. Think of the dozens of the household products you use on a daily basis, and Procter & Gamble makes it. And that makes them a great company to hold for the long-term, because these are goods you’ll continue to buy whether the economy is up or down. PG currently pays a dividend yield of 3%
Ford (NYSE:F)– Ford pays 5.50% per year in dividends. That’s a 5.50% return just for holding their stock. And the best part about Ford, is that they’re currently one of the leaders in the autonomous driving revolution, and right now, they’re sitting at their most attractive valuation in years — making today a great time to buy American.
In the coming days, I’ll keep you posted on the upcoming Fed rate hikes, and other ways for you to grow your savings before retirement.
Here’s to growing and protecting your wealth!