Bank of America Just Changed Its Fed Call to Three Straight Hikes. The Hit to a Widow’s $400,000 Bond Fund Already Happened, and Her Cash Is About to Get a Raise

Bank of America now expects the Federal Reserve to raise rates at each of its next three meetings, in December, January and March, taking the federal funds rate to a peak of 4.50% to 4.75%, according to a note by economist Aditya Bhave reported by Investing.com on Friday. The bank had expected two more hikes at a quarterly pace and a peak of 4.25% to 4.50%. “After Oct CPI, the Fed looks further behind the curve on inflation,” Bhave wrote. “It no longer has the luxury of hiking at a quarterly pace.”

The Fed’s target range sits at 3.75% to 4.00% after its September increase, the only one so far this year, so three more quarter-point moves would add 0.75 point. The new call reads as a warning that the inflation fight will run longer than the Fed planned; it is also one bank’s forecast, with the risks “balanced” in Bhave’s own words, and the bond market had already priced three hikes before the note went out, as the bank’s own strategist Michael Hartnett noted the same morning. If you are retired and hold bonds, cash and a CD, the same 0.75 point lands on each of them differently.

Take a widow, 72, a scenario built from the numbers above. Her husband handled the investing, and what he left her is tidy: $700,000 of safe money alongside stock funds and a paid-off house. The $700,000 is $400,000 in a total bond market index fund, $200,000 in a money market fund and $100,000 in a 12-month CD at 4.00% that matures in December. She collects $3,000 a month from Social Security as a survivor and draws $40,000 a year from the IRA. A banker has already called about an annuity. Here is what three hikes would do to each piece, and what you would do in her place.

The money market fund: the raise arrives within weeks

Money funds follow the Fed within weeks. The Crane 100 Money Fund Index, the average yield of the 100 largest taxable money funds, stood at 3.75% on Nov. 11, up from 3.51% six weeks earlier, so the September quarter point has passed through. Three more hikes would take the average to about 4.50% by spring. Her $200,000 earns $7,500 a year today. At 4.50% it earns $9,000, a raise of $1,500. December’s hike alone is worth $500.

That is the whole good news of a rate hike for a saver, and it is modest. Your money fund is the one place where your cash gets a raise without you lifting a finger.

The CD: the raise depends on where she renews, not on the Fed

Her CD paid $4,000 this year at 4.00%. The best widely available 12-month CDs pay about 4.50% now, by The College Investor’s and CD Valet’s November lists, so renewing at the top of the market pays $4,500, a $500 raise. The FDIC’s national average for a 12-month CD was 1.73% in September; at that rate her $100,000 earns $1,730. The gap between the average and the best is $2,770 a year, more than ten times what December’s hike could add.

Should she wait for the hike before renewing? A quarter point is worth at most $250 a year on $100,000, and the market has already priced it: the 3-month Treasury bill yielded 4.30% on Nov. 10 and the 2-year note 4.73%, against an effective fed funds rate of 3.88%, and banks price 12-month CDs off those bills. Waiting buys you little. Shopping buys you a lot.

The bond fund: the damage is already done, and the income is up

This is the piece that confuses people. A rate hike by itself does not cut your bond fund’s price. The expectation of hikes does, and that expectation has been building all year. The 10-year Treasury yield rose from 4.19% on Jan. 2 to 4.98% on Nov. 10, by Treasury data, and touched 5.31% on Oct. 5. Vanguard’s Total Bond Market ETF, the largest fund of the kind she owns, lists a duration of 5.7 years as of Sept. 30: its price falls about 5.7% for each one-point rise in yields. A 0.79-point rise times 5.7 is a 4.5% drop; the fund’s price fell 4.6%, from $74.07 on Dec. 31 to $70.65 on Thursday.

Her 5,662 shares, worth $400,000 today, were worth $419,363 at the start of the year. The $19,363 of price loss has already happened. Against it, the fund has paid $2.95 a share in distributions over the past 12 months, 4.18% on today’s price, or $16,712 a year on her holding, and its yield to maturity was 5.6% at the end of September, so the money inside it is being reinvested at higher rates.

From here the arithmetic runs both ways. If Bank of America’s upside risk plays out and yields rise another half point, the fund drops about 2.85%, or $11,400. If the 10-year falls below 4.5% in December or January, as Hartnett expects, a half-point drop adds about $11,400.

So the bond fund is where she should not act on the headline. Selling it now to sit in cash locks in the drop and swaps 5.6% to maturity for 3.75% today. If you own a fund like it, the hikes you are reading about are already in its price.

The annuity call: the Fed's next vote is not what sets the rate

The banker’s pitch is a five-year multi-year guaranteed annuity, the simplest kind: a fixed rate for a fixed term. The best five-year rate from an insurer rated A- or better was 6.30% on Nov. 12, by Annuity Expert Advice’s rate table, against 4.81% on the 5-year Treasury and 5.00% on the best 5-year CD. On $100,000, five years at 6.30% grows to $135,727, against $126,478 at the Treasury’s 4.81%: an edge of $9,249 before tax.

Two things to know before you sign one. Insurers set these rates from corporate bond yields, and several cut them this week while the Fed talk got louder: Nationwide’s five-year dropped to 5.95% on Nov. 9 and Lincoln’s to 5.85% on Nov. 10. A hike in January does not raise your rate once it is locked. And the money is locked: a typical first-year surrender charge of 7% would cost $7,000 of the $100,000 if she needed it back. For a widow deciding alone, any product with a surrender schedule deserves a second opinion from someone who does not sell annuities.

The HELOC

Her house is paid off, so a hike changes nothing there. If you carry a home equity line, it does: the prime rate is 7.00% and moves the day after each Fed decision, and three hikes put it at 7.75%. A line at prime plus half a point goes from 7.50% to 8.25%, so a $50,000 balance costs $4,125 a year instead of $3,750. A fixed 30-year mortgage, 7.11% this week by Freddie Mac, does not move.

The tax on the raise

Her $36,000 of Social Security, $40,000 of IRA withdrawals and $28,212 of interest and fund distributions put her provisional income at $86,212, past the $34,000 line, so 85% of her benefit, $30,600, is already taxable. After the $16,100 standard deduction, the $2,050 addition for being over 65 and the $4,571 of the $6,000 senior deduction that survives its phase-out, her taxable income is $76,091, in the 22% bracket for a single filer. The $2,000 raise from the money fund and the renewed CD costs $466 in federal tax, counting the slice of senior deduction it erodes. She keeps $1,534.

The bottom line

If Bank of America is right, her cash gets a $2,000 raise before tax and $1,534 after it. Her bond fund already took its $19,363 hit; it pays her $16,712 a year to wait, and each half point from here is $11,400 in either direction. The annuity rate is set in a different market and drifted down this week. The Fed meets Dec. 8 and 9, Jan. 26 and 27 and March 16 and 17, and Bhave himself said it could skip the last hike if the data soften. The one decision the Fed does not make for you is where the CD renews, and for her that is worth more than all three hikes put together.

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