Strong Feb Jobs Means Fed Rate Hike

Get ready for a Fed interest rate hike next week. The February jobs report showed that the U.S. economy added a larger than expected 235,000 jobs, the unemployment rate edged down to 4.7 percent and annual wage growth bounced back from a revised 2.6 percent in January to 2.8 percent, ahead of the 2.7 percent average seen in the second half of last year. The increase in wages demonstrates that the labor market is tightening and that state-level minimum wage hikes are filtering through the economy.

With this report and given that Fed officials, including Chair Janet Yellen, have been talking up the potential of a March increase, it looks increasingly likely that the central bank will increase short-term interest rates by a quarter of a percent when it meets next week. If Fed officials pull the trigger, it would be just the third rate hike in a decade.

Job growth over the past three months has averaged 209,000 and over the past year, there have been 2.35 million jobs created, a solid pace this deep into a recovery. Drilling down, some of the other internals in the report were encouraging. The unseasonably warm February weather resulted in a 58,000 gain in construction, following a 40,000 increase in January; manufacturing added 28,000 jobs; and despite the Trump administration’s hiring freeze, Federal government employment rose by 2,000. There was a 26,000-drop in retail, though that follows a gain of 40,000 in the prior month.

The unemployment rate, which has been at or below 5 percent for a year and a half, is just below the central bank’s median longer-run projection of 4.8 percent and the broader unemployment rate, which includes disgruntled workers and those working part-time, but would prefer full time jobs, edged down to 9.2 percent, down from 9.8 percent from a year ago, though still remains slightly above pre-recession levels.

HOW WILL THE FED’S ACTIONS IMPACT CONSUMERS?

Savings: Any increase in the Fed Funds rate could help nudge up rates on savings accounts, but after the first two increases, banks passed very little of the increase on to customers. That said, the trend is looking up for beleaguered savers.

Mortgages: Rates for fixed rate mortgages key off the 10-year government bond, not short term rates that the Fed controls. Yields on the 10-year have been creeping up to about 2.6 percent, near the high hit in January. According to Freddie Mac, the average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($417,000 or less) increased to a 2017 high of 4.21 percent, up from 3.5 percent four months ago. Adjustable rate mortgages (ARMs) are linked to shorter-term rates, which means that consumers should be careful about assuming these loans and also should consider locking in a fixed rate now. Those who have ARMs could see payment increases down the road.

Auto Loans: For those planning on purchasing a new car with a loan, don’t worry too much. An extra quarter-point increase on a $25,000 loan amounts to a few dollars a month in higher payments.

Credit Cards: Most credit cards have variable rates and unlike the savers, the card companies are quick to pass along the increase to the borrowers within a few billing cycles.

Student Loans: Federal loans are fixed, so there will be no impact from a rate increase, but some private loans are variable. Double check your paperwork to determine what benchmark rate (Libor, prime, T-bill) your loan is tied to.

HOW WILL THE FED’S ACTIONS IMPACT INVESTORS?

Stocks: Given the stock market’s bounce after the release of the jobs report, it’s now safe to assume that investors are fine with a hike next week. But if the central bank ends up raising rates faster than expected, it could hurt prices. In the past, shares of banks, energy, industrials and technology do well amid rising rates.

Bonds: When interest rates rise, bond prices fall and in this particular cycle, it could be even more painful, because the slow growth recovery lulled many bond investors into complacency. That said, there is no reason to abandon the asset class. For most investors who own individual bonds, they will hold on until the bonds mature and then purchase new issues at cheaper prices/higher rates. For those who own bond mutual funds, they will reinvest dividends at lower prices and as the bonds in the portfolio mature, the managers will reinvest in new, cheaper issues with higher interest rates. In other words, being a long term investor should help you weather rising interest rates, though you may want to consider lowering your duration, using corporate bonds and keeping extra cash on hand. (For more on bonds, check out this post.)