At the close of its June 13 meeting, the Federal Open Market Committee (FOMC) announced that it raised the federal funds rate by 25 bps, to a target range of 1.75 to 2.0 percent. This is the second rate hike of 2018 and the seventh since normalization began in December 2015.
A higher interest rate environment might have some investors worried—but ultimately, the FOMC moving to raise rates should instill confidence in investors. When the broader economy is growing—with higher wages and strong job growth—investors can benefit from favorable rents and increased values. However, investors should be thinking about how a higher rate environment might affect their portfolios and consider the proactive steps they can take today to prepare.
The data since March’s hike have been mostly in line with the Fed’s outlook—and its comments coming out of today’s meeting, although more hawkish than previous announcements, signal that rate hikes should remain gradual. In May, the unemployment rate fell to an 18-year low of 3.8 percent, and the four-week rolling average for weekly jobless claims fell to 216,000, which is the lowest the average has been since December 1969.
Notably, wages have not picked up in tandem with the tighter labor market, but they’re closer to the Fed’s long-term inflation target of 2 percent than we have been since the recovery began. The Fed has indicated that being slightly over that target is no more alarming than being slightly under, which should help to cool worries that it will pick up the pace of its interest rate hikes if inflation overshoots its target. After today’s increase, the FOMC’s statements indicate it now expects two additional increases in 2018 for a total of four hikes for the year, as opposed to the total of three it called for out of the March meeting. Three additional hikes are still expected in 2019.
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Source: J.P. Morgan Markets, as of June 8, 2018
If economic growth continues to accelerate and the economy moves closer to operating at its full potential, we can expect the Fed to continue its rate normalization process. Investors should be preparing for a higher interest rate environment by structuring their portfolios to withstand an increase in rates. We tell our clients they should be thinking 200 to 300 basis points higher—and if that increase will break the deal, it’s likely not a smart investment.
One thing we’re getting asked by our clients is how to approach rate resets and loan maturities. Nobody has a crystal ball for interest rates or the economy’s trajectory, but investors can prepare for an uncertain future by taking action today to protect themselves from the unknown down the line. During the financial crisis, we saw clients who had a significant amount of loans maturing when rates weren’t great, valuations weren’t great and liquidity wasn’t great. That’s not an ideal position to be in.
We tell our clients to think about where rates might be in a year or two years, or even 10 years. It might be 4.5 percent today, but it could be 6 percent in a year. You don’t need to sign anything today, but take a close look at your maturity dates and rollover dates and be strategic about when they hit. Consider spreading them out so you don't have to act on all of them at once, when conditions might not be what you had hoped for.
Cycles come and go, and you don’t know exactly if, when or why a correction will hit. The rearview mirror is small and you can’t spend all of your time looking at it, but it’s important to remember that the worst time to have to sell is in a down market. I often hear from our top clients that they approach their business similarly to the way our firm does: They create a fortress balance sheet so they’re successful and in a position to capitalize on opportunities, regardless of where we are in the cycle.
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