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The Federal Reserve Is Raising Interest Rates. Here’s Why And How It May Impact You.

After strong jobs report, all eyes are on the Federal Reserve.  In the wake of this boom, the Fed is gearing up to raise borrowing costs in the U.S. this week.  Why?  The economy is growing fast enough to boost inflation to the highest level in years, and we’re moving from a light to heavy economic swing.

So much depends on how we feel about the economy.  Take for instance our reaction to the statistics that swirl around about job growth.  When we hear our country just lost 150,000 jobs we fret that our own job might be in jeopardy and as a result perhaps spend less.  Of course, the reverse is also true.  If we hear about a 235,000 growth in jobs during a month, we all start to feel optimistic about where the economy is headed.

Why The Jobs Report Matters

While the Fed may not have feelings, per se, it’s certainly keyed in to the numbers.  The jobs report is one of the primary data sets the Fed analyzes when considering changes to its interest rates.  The mission of the Fed is to maximize sustainable employment and keep prices stable, which mostly means keeping inflation in check.  In today’s economy, Fed members would like to keep inflation around 2% per year.

Related: Protect Yourself From The Fed’s Next Move

The Department of Labor’s latest jobs report, released Friday, shows that firms are not only hiring at a strong pace but that wages are rising as well.  According to this report, the unemployment rate is now 4.7%, and the U6 rate (which measures workers who are part-time purely for economic reasons) is at 9.2%.  Labor force participation rose to 63%, up a tenth of a percentage point from just January of this year.

Turning back to inflation, the Fed watches the Personal Consumption Expenditure (PCE) price index as a measure of inflation.  The latest report indicates that the PCE rose to 1.9%.  The so-called core rate, which excludes food and energy, rose 0.1% after being flat for January, and the year-to-year inflation rate is 1.7%.  So, we’re pretty close to the 2% target.

What The Fed Decided

Taking all these numbers together, the Fed announced Wednesday afternoon that they are aiming to ratchet rates higher. Specifically, they’re aiming to raise the key interest rate for overnight lending by a quarter-point, from a range of 0.5 percent to 0.75 percent to a range of 0.75 percent to 1.0 percent. If you were watching the bond market, you saw this coming.  There’s been a 10-year Treasury rate climb over the last several months to just over 2.5%, possibly caused by optimism about President Trump’s economic policy promises.  If you recall, this summer the rate was down below 1.4%.

Related: Why Bonds Still Matter

Let’s close the loop here.  These numbers illustrate why I’ve been so focused this year on managing interest rate risk inside the safe side of your portfolio.  There’s no doubt that you still want bonds for safety and income; it is by no means time to abandon all bonds.  But it is time to acknowledge that rates have bottomed out, and we are probably looking at a long period of flat to higher rates.

For you income investors out there, it’s a simple matter of making adjustments to what you hold, if you haven’t done so already.  Keep in mind, there are plenty of dividend paying companies, short-term bonds, floating rate bonds, adjustable rate bonds, higher yielding bonds, and certain real estate investment trusts out there to round out your portfolio.  Vehicles like these should do just fine, even in an environment where rates continue to climb.

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