Janet Yellen, the chair of the Federal Reserve, has said that the Fed is likely to raise its benchmark interest rate sometime this year. Such a move would be the first rate rise since 2006. Whether the change occurs as early as the Fed’s meeting next week or later in the year is still a matter of speculation, but either way higher interest rates could affect your portfolio. So how much should you fret about the Fed’s potential move? The answer is “probably not too much.”
That sanguine answer isn’t because the Fed doesn’t matter. The Fed’s decisions can affect the value of essentially every investment you own. Rising interest rates could increase bond yields and therefore hurt bonds (since bond prices and yields move in opposite directions). They could potentially slow the economic growth rate, hurting stocks. They could strengthen the US dollar compared to foreign currencies, reducing the values of your international holdings as well as causing commodity prices to decline.
But the Fed has been clear about its intentions to raise interest rates for a while. Even Ben Bernanke, the Fed chair before Yellen took over in 2014, had discussed when and how the Fed would raise interest rates. As a result, many of the effects of higher interest rates may have already occurred in anticipation of the Fed’s potential move. For example, it’s likely that some of the gains for the US dollar compared to foreign currencies during the past year (and the interrelated struggles of commodities and emerging market investments) resulted from the possibility of the Fed raising rates.
Furthermore the Fed may not exactly follow the historical playbook this time around. Usually when the Fed starts raising interest rates, they continue with a series of fairly rapid rate rises over the course of a couple years. That pattern occurred in the early 1980’s, the late 1980’s, the early 1990’s, the late 1990’s, and the mid-2000’s. But Yellen has said that this time the Fed plans to raise rates more slowly than usual.
She may not have much of a choice. Developed countries that have raised interest rates in recent years— including Sweden, Norway, and Australia—have had to quickly reverse course when their economies subsequently stagnated. With the inflation rate still below the Fed’s 2% target and a weak global economy, the Fed is unlikely to raise rates very far or very fast.