The Federal Reserve voted Wednesday to raise a key short-term interest rate for only the third time in more than a decade — since the onset of the global financial crisis.
However, the quarter-point hike was also the second rate increase in just the past three months, a signal that the central bank finally believes the economy, job market, and possibly inflation are heating up.
“The important thing to me isn’t that the Federal Reserve is raising rates, but why the Fed says it’s raising rates,” says Scott Clemons, chief investment strategist at Brown Brothers Harriman. “The improvement in the labor market warrants a rate increase, and there’s enough economic strength to support it.”
What does that mean for investors? Here’s what you need to know.
Your Stocks: Good News
There was a time, not too long ago, when a decision to increase interest rates would have sent investors running for the hills. Not so today.
The stock market is up big league since the last hike in December, and that’s because of the signal Wall Street is receiving from the Fed. In short: the economy is strong.
“This is good for stocks,” says Clemons. “At the end of the day, the ultimate driver of returns is corporate earnings, and the ultimate driver of that is the economy.”
Already, the profit outlook is improving demonstrably. In the first quarter, earnings growth among companies in the S&P 500 index of U.S. stocks is expected to jump 8.9%, according to FactSet, after rising just 0.4% in 2016. For the full year, Wall Street analysts are expecting U.S. corporate earnings to grow nearly 10%, exceeding the long-term historic average.
Today’s Fed decision illustrates just how far the economy has come since nearly imploding during the worst financial crisis in generations. Employers are adding more than 200,000 jobs a month. Workers are starting to see sustained modest gains to their paychecks. There are fewer long-term unemployed people. And workers are quitting their jobs — a sign that they think they can get a better one – at higher rates.
Meanwhile, the bull market recently entered its ninth year while the economy expended at a healthy clip toward the end of 2016.
All of which means get ready for higher interest rates for the rest of this year, and next.
“The current view at the Fed—based on the quarterly projections it releases in December, March, June and September—is that it will raise rates three times this year and twice in 2018,” says Kathy Jones, chief fixed income strategist, Schwab Center for Financial Research.
Your Bonds: Meh
Bonds are traditionally considered a loser when the economy simmers and interest rates rise. Concerns over higher inflation, price increases are nearing the Fed’s target limit, dampen demand for low-returning fixed income investments in favor of higher-returning equities. That’s why you’ve seen yields on 10-year Treasuries skyrocket in recent months, as bond prices have sunk.
Given that multiple increases are on the horizon, it’s time to hit the sell button right?
Not quite. While you may lose out on the bond price, over the long haul, increased yields will make up the difference.
“It may sound perverse, but there is a benefit to rising rates,” Matt Toms, chief investment officer for fixed income at Voya Investment Management, recently told MONEY’s Carla Fried. “If you’re patient and are reinvesting the income, over time you are going to be better off with the higher income payout.”
Still long-term bonds bear the brunt of rising rates, so you might tilt your portfolio towards short-term funds, especially those that focus on financially strong companies. Consider Vanguard Short-Term Investment Grade (VFSTX), which is in the MONEY 50, our recommended list of mutual funds and ETFs.
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Your Cash: Looking Up
Perhaps no group loathed the Fed’s low-rate policy of the past decade more than people who have a large chunk of their assets in cash.
A one-year certificate of deposit yielded 3.8% in January 2007, according to Bankrate, but that was down to only 0.3% last year. It’s tough to live on that kind of return if you’re a retiree.
“This is a boon for savers,” says Clemons. “If the Fed carries through with another two or three rates hikes this year, you’ll see a real rate of return on idle cash for the first time in decade.”