All attention is once again on Janet Yellen and the Federal Reserve this week, as the FOMC meets to determine whether an interest rate hike is warranted.
At this point, with Fed Funds futures prices pointing toward a 95% chance of a rate hike, an increase to the federal funds rate is a near certainty. But the implications and consequences of a rate hike are less so. Let’s dig into that further.
One thing I’ve noticed in speaking to investors is that there is often an inclination to group all interest rates together. When they hear about the Fed “raising rates,” many assume that interest rates across the board, for nearly everything, will rise. This couldn’t be further from the truth and warrants more explanation.
Interest rates come in all shapes, sizes and most importantly, maturities. That is, the length of the term over which money is borrowed, and therefore accrues interest.
Take US Treasuries as an example. If you want to loan the US government money, they’ll pay you a different interest rate based on the term of the loan. You can see today’s pricing for a few select maturities in the table below:
If we take these maturities and their respective interest rates and plot them on a chart, we end up with what’s known as the yield curve. You can see this as the red line in the chart below.