This week brought long-awaited although not unexpected news from the US Federal Reserve Board: Fed officials expect to raise interest rates from the current level of “near zero” by the end of 2023 instead of sometime in 2024. Earth-shattering? NO. Cause for paying attention? YES. Even though 2023 seems fairly distant, interest rates have already begun to increase. It is not too early to pay attention to, review, and understand your overall Asset Allocation. Thus, today’s title, “CYA”. Cover Your Asset Allocation.
As quick background, the US Federal Reserve System, or the “Fed”, has as its mandate to maximize US employment and allow for stable prices. Its primary tool for accomplishing these goals is the setting of short-term interest rates – which then translate into to interest rates for anything from 30-day Treasury bills to 10-year Treasury notes, to 15- and 30-year mortgages. Even debt issued globally watches the Fed’s interest rate policy.
The signal this week by the Fed of a possible 2023 interest rate rise means that they have already been thinking about a rate rise for months. (Setting higher interest rates is one way for the Fed to fight inflation.) One of the primary reasons interest rates started rising meaningfully all by themselves back in early January 2021 is that the market expected inflation to creep – and it now has crept – into prices for all sorts of goods and services. Check the cost today versus back in 2019 or 2020 for a basic breakfast of eggs, bacon, and toast or even cereal. How about the cost to build a new house or construct a new deck or addition to an existing home? How about trying to find a contractor to do that work? How about the price for a tank of gas? There was little warning for these market price increases.
But the US Fed has its hands somewhat tied by hedge funds, huge asset managers, and banks. These institutions have spent the past 10-12 years convincing the Fed to give ample warning of even the whiff of an increase in short-term interest rates. After the 2008-2009 financial crisis and now amidst the post-coronavirus pandemic the Federal Reserve has become involved more than ever in history in the inner workings of interest rates. And they have been almost forced to broadcast any inkling of a change in rates.
So, if the Fed says out loud that several of their officials are “penciling in” a rate rise in 2023 instead of in 2024, that means pay attention TODAY.
- Understand how comfortable you might be in 2021-2022 with a bumpy ride for overall stock prices. (Stocks tend to go down when interest rates are on the rise.)
- By the way, this does not mean to sell all your stocks! Being prepared means understanding your asset allocation (CYA) and being ready to accept a possible repeat of March 2020 – with perhaps an eventual recovery in an unknown time frame.
- Arrive at a percentage allocation to stocks (CYA) that makes sense for your short- and longer-term future growth needs. Stocks still beat the heck out of bonds when it comes to long-term growth potential.
- Be ready to accept still low rates of return on cash held at the bank – and be OK with that – in order not to have to sell equities in a downturn.
- Hold an “intelligent amount” of cash (CYA) – meaning a level of cash that lets you sleep at night.
- Work with your adviser to construct an asset allocation that aims to accomplish goals in the short-, intermediate- and long-term.
The US Federal Reserve has given their warning about higher interest rates. The real time frame for individual investors to pay attention needs to be far sooner than 2023.