Investors have been euphoric in recent weeks over the potential for interest-rate reductions by the Federal Reserve.
Even after some strong jobs numbers came out Friday, interest-rate futures positions indicate a 70% chance for a Fed rate cut in March. And the indicated probability is 60% that the Fed will slash rates by at least 1.5 percentage points this year as a whole.
Investors seem to have gone overboard in their expectations. The median forecast of Fed officials calls for about 0.75 percentage point of rate cuts this year. And these officials have made clear they anticipate keeping rates higher for longer.
After Friday’s employment data, a rate hike in March looks extremely unlikely. Payrolls climbed a higher-than-expected 216,000 in December. And wages gained 0.4% from November and 4.1% year on year.
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It’s no slam dunk that the Fed will ease at all this year. No one knows for sure how the inflation and jobs statistics will play out in coming months. But let’s assume the Fed makes three 25-basis-point (0.25 percentage point) reductions along the lines of its median forecast.
What you can do if interest rates decline
What’s an investor to do in a declining rate environment? First, keep in mind that there’s no need to panic. At this point, the Fed appears highly unlikely to move before May. So you have plenty of time to adjust your financial strategy.
One suggestion: If you want to buy certificates of deposit this year or bonds that you’ll hold to maturity, make those purchases sooner rather than later. That way you’ll lock in today’s lofty rates before they fall.
Through Fidelity Investments (full disclosure: I’m a customer) you can get a two-year Citibank CD yielding 4.65%. On the bond side, you can get a single-A-rated Toronto-Dominion Bank bond yielding 5.4% (full disclosure: I own TD Bank bonds).
And if you aren’t ready to lock up your money, you can still prosper in money-market funds for a while. They’re yielding more than 5% and will likely continue to do so until the Fed cuts rates, which, again, may not happen until the spring or second half.
Another suggestion: If you’re a renter who wants to buy a home, you might wait until the Fed acts. Mortgage rates should fall at that point. The 30-year fixed mortgage rate stood at a lofty 6.62% on Thursday, according to Freddie Mac.
Finally, any money borrowing that you can put off until the Fed acts on rates should cost you less at that point. Consumer loan rates should fall in line with the federal funds rate controlled by the Fed.
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