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What a hike means to you
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June 30, 1999: 3:22 p.m. ET
Experts say the quarter-point increase won't cut into your wallet by much
By Staff Writer Alex Frew McMillan
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NEW YORK (CNNfn) - When Alan Greenspan et al at the Federal Reserve boost interest rates, that cuts into most consumers' pocketbooks. Home loans, car loans, credit-card balances all get a little more expensive.
But the quarter-point increase doesn't make that much difference, economists and market watchers say. What's more, the financial markets anticipated the increase in the federal funds rate well ahead of the Federal Open Market Committee's announcement Wednesday.
As a result, much of the rate hike already has been priced into financial products like mortgages, where rates have risen substantially during 1999 in the face of inflation fears. That means the effects of the hike will be small and not all that noticeable to consumers, experts say. And some economists say the Fed's pre-emptive strike to curb inflation could even bring individuals' costs down.
"Consumers shouldn't jump on what to do with their personal spending based on what happens to rates," said Jim Smith, chief economist at the National Association of Realtors.
Yes, in the short term, the cost of borrowing gets a little higher. One certainty is that any home equity loan with a floating rate tied to the prime interest rate will go up, Smith said. But the rate hike is good news for markets and consumers in the long run that the economic expansion will continue. "Consumers should take it as a good sign the Fed is on the job," Smith said.
How the hike hits home, literally
The fed funds rate influences interest rates on a wide variety of loans. So raising the rate could boost a lot of consumer costs, assuming it filters through.
Mortgage rates tend to key off the 10-year Treasury, for instance, while shorter term loans like car purchases key off the five-year Treasury. As short-term interest rates rise, those longer-term interest rates tend to rise, too.
David Littmann, chief economist at bank Comerica Inc., worked out that a quarter point increase in a $100,000 loan for a 30-year mortgage, to 7-7/8 percent from 7-5/8 percent, adds $17.28 a month, or $6,221 over the life of the loan. "That would bite on disposable personal income at the end of the month," he said.
A quarter point increase on the average car loan, from 7 percent to 7.25 percent, would add $2.33 a month to the bill, he said, "not a lot of difference." The average loan on a $24,000 car is $22,109, the National Automobile Dealers association reports, and the monthly payment on that would rise from $485.63 to $487.82.
The rate increase has a negligible impact on credit cards, according to Littmann. The average balance for people who carry one is now at $1,800, he said. So the average payment would increase 37 cents a month, to $28.87 from $28.50, if the annual percentage rate rises from 19 percent to 19.25 percent.
Those numbers aren't guaranteed
But there are lots of "ifs" about the quarter-point hike in short-term interest rates. Littmann is not sure the increase will be passed through to consumers. For instance, he thinks auto makers will offer financing incentives that will offset any increase. And by acting pre-emptively, the Fed may actually drive long-term mortgage rates down, Littmann said.
With signs the Fed is combating inflation, mortgage lenders may feel more confident in offering attractive deals, some economists say. So the net effect of a small increase in interest rates is good for economic stability, which is good for consumers. "Your pocketbook isn't going to be impaired, but your long-term outlook is going to be enhanced," Littmann said.
The housing market often is viewed as the most interest-rate sensitive sector of the economy. So David Seiders, chief economist of the National Association of Home Builders, does expect home sales to slow. He predicts housing starts will decline from a 1.8 million annualized rate in the first quarter to 1.49 million by the fourth quarter.
But with labor tight for home builders and a supply bottleneck on some construction products like gypsum wallboard, that may be a good thing. "I'm advising [home builders] quietly not to make a big fuss," he said. "Some cooling off is frankly to our benefit."
Unlike the real estate cycles that led to recessions in the early 1980s and 1990s, there's very little speculative building or signs builders have overbuilt.
So demand will slacken short term, but the builders couldn't keep up with demand anyway. The homes that aren't built this year will be built next year, he thinks. This "will cause some buyers to step back," Seiders said, "but we'll get them back later."
Car dealers take the news in neutral
For car dealers, "interest rate increases aren't helpful," said Paul Taylor, chief economist at the National Automobile Dealers Association. "But the impact is already out there." The real issue is whether the Fed ultimately will raise rates two or even three times this year, he said.
For now, the quarter point boost leading to a $2-a-month increase in the price of a car loan will have a "minimal effect" on car sales. "There's some buyer out there who makes his choice not to buy when things go up by just a few dollars," but that's rare, he said.
Tom Keery, who runs Cadillac and Nissan dealership Frost Motors Inc. in Newton, Mass., said a small interest rate increase doesn't have a big impact. "You take a deep breath and move on," he said. For luxury cars like Cadillacs, the overall health of the stock market drives purchasing. Car leases are typically tied in at long term "captive rates," he said, "so it will have zero effect there."
A quarter point increase may put off some "reachers," people who aspire to own a more expensive car than they really can afford, said Lou Kairys, who runs Lustine Auto Group Inc. in Washington, D.C. But a small hike doesn't affect consumers' willingness to purchase, just their price range, he said. "It may stub your toe for a week or two but it'll come back."
Impact on markets
The stock market should take the interest rate hike in stride. That's because the Fed's action is aimed at bolstering economic growth, long-term wage gains and the stock market. Even though rate increases normally hurt the stock market, those Cadillac buyers shouldn't have too much to worry about, according to equity strategist Marshall Acuff at Salomon Smith Barney.
Higher interest rates can threaten to cut corporate profits, but "there's just not much impact" on the stock market from this quarter-point increase. "What would be important is a series of increases." That seems unlikely with the Fed announcing it has shifted its bias away from tightening rates to a neutral stance in the future.
Al Goldman, chief market strategist for A.G. Edwards, agreed a quarter-point increase doesn't have much effect. "Second quarter earnings are going to be a very pleasant surprise," he said. "A quarter point increase won't even cause the economy to sneeze. It's so modest it will not be a factor."
Companies that have to borrow for expansion see their costs increase. So some may shelve a few short-term plans. "A lot of businesses will see the cost of capital moving higher temporarily," Littmann said. And companies may postpone some debt and bond issues, hoping for better rates later, he said.
Consumer confidence to stay high
But the news in the long run is good. Over the next two to three months, Dick McCabe, chief market analyst at Merrill Lynch, anticipates a correction of up to 10 percent, or 15 percent at the outside, off the stock market's highs. Then the bull market will resume later this year, he thinks.
So the Fed's announcement should be good long term news, most experts say. The Fed's move does mean car loans will be negligibly more expensive, credit cards won't be affected and long term rates will go down, Smith at the Realtors' association said. But the signs this is an "insurance policy" quarter-point increase should have the markets rejoicing.
"My bet is long term investors will be heartened by the Fed being ahead of the curve," he added. Long-term interest rates will go down as a result, he said.
For the man on the street, Littmann at Comerica said, the main effect of the increase is that confidence should stay high. "It means the economy will continue to do well. But there's a speed limit out there the Fed would prefer."
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