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WHEN THE FEDERAL RESERVE (Fed) raised rates a few weeks ago, it was the first hike of the year. Last year, we had three hikes. How many more could we see in 2018, and how might they affect the markets and your finances? Below, Matthew Diczok, head of Fixed Income Strategy, Merrill Lynch Wealth Management, provides some answers.
Q: So, Matt, how many more rate hikes might we see this year?
A: We expect that the Fed is going to raise rates between three and four times in total this year—currently, we think there will be two more hikes, supported by the Fed’s positive outlook on the economy, especially the strong job market. The main reason they might hold the line on hikes is if inflation stays persistently below the Fed’s inflation target of 2%. Some other things that would prompt the Fed to put the brakes on are significantly tighter bank lending standards, a surge in unemployment, or any unforeseen shock to the US or global economy—none of which we expect right now.
Q: What impact could rate hikes have on our finances?
A: Mortgage interest, as well as the interest consumers pay on credit card debt, could get slightly more expensive as rates continue to rise. From an investor perspective, the effect on stocks and bonds varies. Typically when rates are rising, the market value of existing bonds declines. So the price of the bond or bond funds you own will most likely drop. But you’ll be able to use the interest you earn on your existing bonds and the principal you receive at their maturity to purchase new bonds or reinvest in bond funds with higher yields. As for stocks, gradually rising rates generally signal a favorable economic environment, and should not in and of themselves be a real headwind for equity markets.
Q: Does it still make sense to own bonds now that interest rates are rising?
A: Regardless of what happens with rates, bonds provide steady income, and bond prices are generally both less volatile than stock prices and may move in a different direction. They are an important component of a well-diversified portfolio. Watch Market Decode: Why Bonds (Still) Matter, Even When Rates Are Rising below for more insights on the potential impact of interest rate hikes on the bonds you own. Then schedule some time with your advisor to review the amount of diversification you have in your portfolio.
Investing involves risk including the possible loss of principal investment.
Investing in fixed income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices typically drop, and vice versa.
Investments in high-yield bonds (sometimes referred to as “junk bonds”) offer the potential for high current income and attractive total return, but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a junk bond issuer’s ability to make principal and interest payments.
Income from investing in municipal bonds is generally exempt from Federal and state taxes for residents of the issuing state. While the interest income is tax-exempt, any capital gains distributed are taxable to the investor. Income for some investors may be subject to the Federal alternative minimum tax (AMT).
Investments focused in a certain industry may pose additional risks due to lack of diversification, industry volatility, economic turmoil, susceptibility to economic, political or regulatory risks, and other sector concentration risks.