Interest rates may rise at any time
When will interest rates rise? The Federal Reserve Board has kept the federal funds target rate at 1 percent early into 2004, though Chairman Alan Greenspan and company may decide to tighten credit sometime later this year.
Meanwhile, bond and mortgage rates generally have been heading higher since last summer.
"A 1 percent federal fund rate is unreasonably low from a historical perspective and unreasonably low compared to the type of growth we're seeing now," said Anthony Chan, senior managing director and chief economist at Banc One Investment Advisors.
Chan believes the economy, as measured by gross domestic product (GDP), will probably grow 4 percent this year.
"Historically, we have never seen a 1 percent fed funds rate when the economy is growing at 4 percent or higher," he said.
So why has the Federal Reserve kept rates so low? "Global deflationary forces," Chan said.
"The Chinese are dropping a lot of products here, keeping prices down" and, he adds, "Companies do not have a lot of pricing power and are not having to pay high wages."
The most recent U.S. employment report shows average hourly wages rising by 2 percent. You have to go back to March 1987 to find another period in U.S. history when wages have risen this slowly.
Chan, who oversees $185 billion in equity and fixed income investments, believes rates will increase 25 basis points in 2004. He predicts the real avalanche will occur in 2005 and 2006, with rates increasing a full percentage point in each of those years.
"Once the economy maintains a 4 percent growth rate for more than a year, we're going to see the lid come off. Prices will go up a bit, and interest rates will go up in a proportionate fashion. The Federal Reserve will not let inflation run away from them," he said.
So the real question isn't when, but what, meaning what adjustments should you make to your borrowing plans before rates are likely to rise? Here are a few possibilities:
‰Don't hesitate to lock in low rates. For long-term borrowing, saving a percentage point or two on a loan could reduce your total outlay significantly. So even if you've missed the lowest rates, trading an adjustable mortgage or long-term business loan for a fixed-rate loan can still pay off.
At this point in the economic cycle, most observers believe rates are much more likely to rise than fall, and the increase could be substantial. As recently as May 2000, average mortgage rates were at 8.65 percent, according to Bankrate.com. In December 2003, the average was about 5.5 percent.
‰Match your loan to your needs. Even when rates are likely to rise, it doesn't make sense to lock in a fixed rate for a 30-year mortgage if you don't plan to stay in your house nearly that long.
You'll get a much lower rate on a loan that provides a fixed rate for three, five, seven or 10 years — whatever matches your plans. If you're still in the house after that time, you could get a loan adjusted to the prevailing rate.
‰Don't borrow to invest. Mortgage and home equity rates are still low, house prices have soared, and the stock market is improving — so it's tempting to borrow against your home and put the money into equities.
But gambling with home equity is seldom prudent. Rising interest rates could deal a double blow, raising the cost of your loan and choking off the market rally.
‰Eliminate credit card debt. These interest rates will climb and creep up on you. Try to improve the health of your balance sheet.
‰Finally, if you're holding long-term bonds and rates rise, it usually does not result in a capital gains situation.
While no one knows when or how much rates will rise, planning ahead would be in your best "interest."
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