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3 things that matter more to interest rates than the Fed

June 02, 2016

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

Federal Reserve and interest rates

Federal Reserve meetings are probably the most closely-watched economic events in the world. Investors and the business community are anxious for any clue as to the direction of interest rates because those movements have a profound impact on valuations and profitability. However, for all the attention the Fed gets, there are at least three things that are more important to the direction of interest rates than what Janet Yellen and company have to say.

3 things that matter more to interest rates than the Federal Reserve

While the Fed is given credit for slashing interest rates down to near zero, the unsung hero in allowing for bank rates to stay so low has been the near-complete disappearance of inflation. Lenders are not going to accept interest rates that are below the rate of inflation, so in order for interest to stay low, inflation has to be minimal. However, some of the factors that have helped keep a lid on inflation may have reached turning points that could point to more inflation pressure going forward.

Here are 3 examples:

1. Oil prices

Energy is a significant component of the Consumer Price Index (CPI), and the sustained slide in oil prices took a lot of air out of the CPI. If prices become firmer, near-zero inflation is going to be harder to maintain.

2. Job growth

The Great Recession led to a terrible job market with high unemployment. The recovery was slow and halting, but now there have been two years of very good job growth. As a result, the unemployment rate is back down to 5 percent - a level at which competition for labor can put upward pressure on wages. This is another reason why inflation will have a hard time staying as low as it has been recently.

3. Value of the dollar

An easy-to-overlook factor behind the low inflation of recent years is the strong U.S. dollar. Unless you exchange currencies regularly, people in the U.S. don't tend to notice moves in the dollar, but when it is strong, it helps keep a lid on inflation by making imports cheaper. However, after rising throughout most of 2015, the dollar turned downward in the first quarter of 2016 - something that could start to make those imports more expensive.

6 questions to ask ahead of rising interest rates

Those important inflation signals could be tipping you off that interest rates may move higher this year. How does this affect you?

Here are six questions you may face that would all be impacted by a turn in the interest rate trend:

1. Adjustable or fixed rate?

If you are in the market for a mortgage loan, you can get a lower initial rate with an adjustable rate mortgage. However, this would leave you exposed to higher monthly payments if interest rates start to rise.

2. Savings account or certificate of deposit (CD)?

With interest income hard to come by, locking into a long term CD has been a way to do a little better than you would with savings account rates. However, if rates start rising, you might be better off rolling your CDs into savings accounts or at least short term CDs that will let you reinvest more often.

3. Buy now or later?

Thinking of getting into the housing market? You would be hard-pressed to do better than today's mortgage rates, and that could change quickly.

4. Sell your home or wait for the market to recover more?

It's not just buyers that have to worry about mortgage rates. Sellers do better if interest rates are low because buyers can put more of their money to put into the price of the home.

5. Refinance or hold out for more savings?

It is amazing how much refinance volume can change with small changes up and down in mortgage rates. Clearly, some people hold out for a little extra dip in rates before pulling the trigger. Be advised, though, if inflation sparks a sustained rise in bank rates, those short term ups and downs will seem insignificant.

6. Tap into home equity now or let it ride?

Another issue home owners face is when to tap into home equity for things like renovations or additions. If inflation perks up, expect borrowing against home equity to get more expensive down the road.

Millions of Americans have a stake in the direction of interest rates, so it is a good idea to keep an eye on things that impact rates. Instead of just watching the Fed, you can better anticipate events if you watch the same things the Fed watches with oil prices, job growth and the value of the dollar all high on that list.

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