Will the Fed raise rates on Thursday? If the Fed governors do vote for an increase – or if they take no action for now – what does that mean for investing? My answer to clients on all those questions: “I don’t know.”
But I do have a strong answer as to the question of what they should do both before and after the announcement: “Nothing.”
I explain to them that the Fed controls the federal funds rate, which is the overnight interest rate or the shortest of short-term rates. The markets, of course, control intermediate and long-term interest rates.
Granted, the Fed tried to influence longer-term rates with quantitative easing. The goal was to keep demand high for longer-term bonds by buying back government bonds, thus keeping those rates low and providing stimulus for the economy. In 2013, the Fed announced it would taper and then end QE, and economists uniformly predicted rising rates in 2014 and a resulting bond bubble. The Fed did end QE, as promised, and many advisors bailed on bonds or shortened durations. However, what actually happened was that interest rates declined significantly and bonds rallied. In fact, economists have a dismal track record of predicting even the direction of intermediate and long-term rates.
That’s why – if they even ask – I tell my clients two things about the interest decision:
- They should remember this is only the overnight interest rate and nothing more.
- An eventual increase in the federal funds rate is likely already priced into the stock and bond markets. If clients want to invest based on what “experts” are telling us will happen to rates, I caution them about “following the herd.” That typically doesn’t end very well.
It’s quite possible that both equity and fixed-income markets will be volatile based on the Fed action (or inaction). But that shouldn’t matter much for long-term investors. I advise clients to have the courage to ignore the “experts” and their instincts, and stick to their plan.
Allan S. Roth, a Financial Planning contributing writer, is founder of the planning firm Wealth Logic in Colorado Springs, Colo. He also writes for various AARP publications and has taught investing at three universities.
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