Where will interest rates be two months from now?
– On CDs, try about 0.4 percent higher than what accounts currently pay.
– On personal loans, look for up to a 0.33 percent rise in the cost of financing a new car or taking out a line of credit.
– Mortgage rates could be higher, or lower, depending on how successful Uncle Sam is in keeping inflation under control.
The story is this: Another rate increase by the Federal Reserve is a sure bet. It’s not a matter of whether the Fed will act, it’s only a matter of when.
It could happen between mid-August and early September.
The Fed raises rates when it wants to keep the economy cooled down. Higher Fed numbers also mean an immediate increase in the banks’ prime rate, with you winding up earning more on your savings but shelling out more when borrowing.
Fed-watching is second nature to the experts and gurus who infest Wall Street, and who have palpitations at the slightest hint of any rate increase. By contrast, the average Joe understands very little about how the mechanics of a rate rise hits his pocketbook.
The current scenario
Here’s a simplified version of what’s going on, and how it will affect you:
Thus far in 1994, the Fed has pushed up its Fed funds rate (what banks charge each other for overnight loans) four times, from 3 percent to 4.25 percent. The prime rate has also climbed by about the same margin, up 1.25 percent to 7.25 percent.
Except for mortgages, your rates have gone up less than the prime-by anywhere between 0.25 percent to 0.66 percent on loans and between 0.33 percent and 0.5 percent on CDs.
Now, Fed Chairman Alan Greenspan is ready to take another whack at curbing inflation because, based on indicators such as jobs, housing and commodity prices, he sees the economy heating up. The next rate hike could come as early as Aug. 16, during the Fed’s policy-making meeting.
But I’m guessing that it will happen after Labor Day and that the increase will be 0.5 percent, not a 0.25 percent as some of the gurus have predicted. Here’s why:
– Bank CD yields continue to rise by 0.03 percent to 0.06 percent per week. Project that over the next several weeks and you can figure that the banks’ cost of funds since the last Fed hike on May 17 will have risen by more than 0.5 percent by Labor Day.
– To cover themselves-to preserve their nice, fat profit spreads between savings rates and loan rates-banks will have to raise their prime rate from 7.25 percent to 7.75 percent.
– In business and industry, it often takes about three months for the effects of a Fed move to be felt; the medicine goes down slowly. The last Fed increase was May 17. Ninety days after the May 17 date is about Aug. 16.
– Greenspan may want to analyze August economic data, as well, before making his next move. That would postpone the hike until some time in September. Many view that month as the psychological beginning of a business year, after folks return from their vacations.
– A September increase would also match precisely the 1987 upcycle pattern that the banks have followed in ’94. I’ve written about this weird coincidence before, but in both years the first rate hikes by the banks came in March, April and May. The next one in ’87 occurred in September.
The probable impact on your wallet by October?
– $1,000 invested in a one-year CD will earn you about $450, instead of $410 if you open the account today.
– Your total interest cost on a $13,000, four-year new-car loan will rise to $2,460 from $2,360. That on a $20,000, 10-year home-equity loan will jump to $9,250 from $8,800.
– Thirty-year mortgages should still hover between 8.5 percent and 9 percent-provided Greenspan’s elixir works. But after that?
There will undoubtedly be more Fed hikes in the next year because we’re in a long-term upcycle in rates. So borrow now, but don’t lock in any longer-term CDs until the fall. And even then, go short.
Latest rate trend: Steady upward movement in CDs, with Bank Rate Monitor’s ratio of increases to decreases narrowing to 7 to 1 from 11 to 1.
