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Five Things You Should Know About Interest Rate Hikes

Feb 25, 2015

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SMITH BRAIN TRUST -- An interest rate hike could come as early as June, according to a New York Times analysis of Tuesday’s congressional testimony by Federal Reserve Chairwoman Janet Yellen. Similarly, Smith School professor Peter Morici says the Fed “has been giving banks virtually free money by keeping their short-term borrowing rates near zero” -– and this could end “as early as July” as Yellen is signaling Fed optimism about the economy.

“Higher borrowing rates for banks can cause stock prices to tumble, mortgage rates to jump and jobs tougher to find—but not always," Morici says. He offers five things you need to know about the possible hike.

1. Mortgage rates are not likely to change much: When Alan Greenspan increased the fed funds rate in 1994–95, inflation fears also pushed up yields on 20- and 30-year Treasury securities and mortgages. Whereas, when Ben Bernanke pushed up short-term rates in 2004-05, long-term rates did not similarly jump because fears about future inflation were subdued and China was printing money at a maddening pace to keep the yuan cheap against the dollar. A lot of that Chinese money came to America and pushed down mortgage rates. Nowadays, the worry is about deflation, not rising prices, and China is joined by Japan, the European Union and other nations in rolling the printing presses. Easy money policies abroad will keep mortgage rates low in America.

2. Bank fees and car loans will get more expensive: New banking regulations designed to prevent a repeat of the 2008 financial meltdown are already pushing up banks’ cost of doing business. Higher short-term rates will make things worse. Look for banks to further boost fees on checking accounts and related services, and charge higher rates for short-term credit -- Visa and MasterCard, car and appliances loans, and home improvements. The good news is banks may start competing more for your money and pay higher rates on checking accounts.

3. Unemployment won’t be much affected: Banks are already downsizing in the wake of heavier regulatory burdens as fast as they can, and higher rates won’t much change that trend. The same goes in the oil industry, where lower crude prices are curbing drilling activity and dampening employment in boom towns. Elsewhere, finding a job is toughest for the long-term unemployed whose skills atrophied during the Great Recession and slow recovery, and for whom government benefits -- expanded Medicaid and food stamps for healthy men -- have often overwhelmed incentives to reskill. If six years of rock bottom interest rates didn’t get idle men off their couches, a few more years won’t help much.

4. Economic growth and inflation will pick up. Consumers will soon start spending all the extra cash that lower gas prices have provided and will overwhelm the growth-slowing consequences of job cuts in the banking and oil sectors. Overall, jobs gains will continue -- likely not as quickly as anyone wants -- but if Europe can avoid mishandling the Greek debt situation, the global economy won’t sink America’s boat. Gasoline prices have bottomed and moderate inflation closer to 2 percent will return by summer. That should make Yellen confident to continue increasing federal fund rates over two or three years.

5. Stock prices will continue strong. Yellen has done a great job of preparing investors for higher interest rates. The economy has emerged from a tough recession and slow recovery, in which the Fed deemed ultra-low interest rates necessary. But in the past decades, the stock market has moved upward solidly with short rates in the range of 3 or 4 percent. That should happen again.

“With a strengthening economy, if you are planning a new car or home improvement, do it now, and if you are an investor on the sidelines, gradually start buying in,” Morici says. “America is not going out of business -- it doesn’t need free money for bankers to thrive.”

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The Robert H. Smith School of Business is an internationally recognized leader in management education and research. One of 12 colleges and schools at the University of Maryland, College Park, the Smith School offers undergraduate, full-time and part-time MBA, executive MBA, online MBA, specialty master's, PhD and executive education programs, as well as outreach services to the corporate community. The school offers its degree, custom and certification programs in learning locations in North America and Asia.

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