MainStreet: Fed's End to Quantitative Easing Will Affect How You Invest and Buy a House
The Federal Reserve’s decision to end its bond buying program after six years to help boost the economy is a sign that more recovery and growth will occur. So what does the typical American on Main Street need to know?
While the Fed did not indicate a timeline for when interest rates will rise, consumers should be prepared and “see the writing on the wall” since variable rates such as credit cards, adjustable rate mortgages and home equity loans will start to rise slowly and gradually, said Bankrate.com chief financial analyst Greg McBride, CFA.
“The low interest rates will come to an end,” he said. “Consumers should pay down debt while the rates are low rather than contend with it once rates move up.”
Mortgage rates will remain low but will fluctuate according to global risks, not because of any actions taken by the Fed, said Ernie Goss, a professor of economics at Creighton University in Omaha.
Consumers should expect rates for short term rates such as auto loans to rise “ever so slightly” between now and July 2015, he said.
The good news about rising interest rates is that savers will begin earning more on their nest eggs, but the increase could be offset by a higher cost of borrowing and could discourage people from getting loans and spending, said Gail Cunningham, a spokesperson for the National Foundation for Credit Counseling, a Washington, D.C. non-profit organization.
“If mortgage rates rise, consumers with variable rate mortgages will see their monthly payments go up, putting a dent in the amount they have available for disposable spending,” she said.
Even if mortgage rates do increase, consumers need to consider the costs of refinancing before they embark on the process, said David Reiss, a law professor at the Brooklyn Law School in New York.
Homeowners need to determine how long they plan to live in their home and if the cost of refinancing outweighs the lower monthly payments.
“If you are not sure that you will be there for a few years at least, the cost of refinancing may be more than the amount you save in decreased interest payments,” he said. “How many years will it take you to recoup that cost in reduced interest rate payments?”
The increase in interest rates could affect consumers looking to buy a home, said Doug Leever, a mortgage sales manager for Tropical Financial Credit Union in Miramar, Fla.
“Higher interest rates would likely affect how much home a consumer can afford,” he said.
The end of quantitative easing means that mortgage rates may begin to “edge upwards,” said Villanova University School of Business Economist Victor Li.
“The Fed is encouraged by the recent strength in housing and hopes that the market is able to sustain a return to more normal mortgage rates,” he said.
The current volatility in the stock market is normal and investors should embrace it as a buying opportunity, McBride said.
“Investors should take a deep breath,” he said. “Long-term investors can buy on the dips in the market and avoid being tempted to lock money up in long-term CDs. Those yields still have a long road to recovery.”
Interest rates will be the most important factor for the markets since the Fed is “propping up the markets and as soon as they stop, it will have drastic effects,” said Matt Tuttle, CEO of Tuttle Tactical Management in Stamford, Conn. Investors should shy away from the classic buy-and-hold strategy since market conditions change frequently now.
“We expect a lot more volatility as we are getting to the end of the bull market and bull markets don't end easily,” he said. “There is more upside, but investors need to tread cautiously. Investors should position portfolios in tactical investments that can appreciate as the market goes higher, but that they can also get out once the crash comes.”
While an interest rate increase may lead to a temporary sell-off in the markets, investors do not need to fear long-term repercussions, said Banu Simmons, a portfolio manager on Covestor, an online investing marketplace with offices in Boston and London.
“Here’s what may happen after U.S. Federal Reserve chief Janet Yellen really turns off the money presses - only a few sectors show major sensitivity to rate increases and among them are building materials, chemicals and personal household products,” she said.
Most industrial, electrical engineering and IT stocks are not negatively affected with the exception of semiconductors and the stock returns of financial services rise with interest rate increases.
While investors are continuing to seek additional yield, they should avoid long-term bonds, said Carl Aschenbrenner, a portfolio manager at Miracle Mile Advisors in Los Angeles.
“We like investments and asset classes that will benefit from low but gradually rising rates,” he said. “It’s impossible to predict when volatility could strike, but it happens often enough that you should always be prepared to take advantage of resulting opportunities.”
The Fed has been propping up the economy and “left the door open if a slack” occurs, said Scott Carter, CEO of Scott Lear Capital, a Los Angeles precious metals firm. What remains to be seen if the economy can withstand the lack of quantitative easing.
“The Fed is ready to save the economy,” he said. “We are not in a healthy recovery.”
Interest rates will not rise in 2015, because the economy is in a “manufactured recovery” and needs continued intervention from the Fed, Lear said.
“The average consumer is really struggling,” he said. “We are not seeing real growth in wages and a recovery in real estate. When money is this cheap, it flows to small percentage of people who own stocks, but it does not flow to the average person on the street.”
Diversifying and rebalancing your portfolio before a correction occurs in 2015 will mitigate some of the risks, Lear said.
“The piper will be paid, because you can’t suppress interest rates forever,” he said. “You can’t create free money forever. The dislocation will be very painful.”
What is unusual is the lack of a market pullback during the past three years, said Chris Costello, CEO of bloom, an online 401(k) tool for consumers based in Overland Park, Kan.
“Market pullbacks are not only normal, they are necessary,” he said. “If it was a consistent upward climb, everyone would be a stock market investor and there would only be a fraction of the return premium afforded to investors.”
When the market dips, investors should take advantage of the declines in stock prices and increase their 401k contributions instead of “running for the hills,” Costello said.
--Written by Ellen Chang for MainStreet