For Fed watchers, last week’s announcement signaled a subtle warning that interest rates will likely begin rising by the Summer of 2015. Since September of 2012, Federal Reserve statements have warned that interest rates would remain unchanged for “a considerable time” after the nation’s economic recovery strengthened. The reference to “a considerable time” was dropped from this past week’s Fed statement and an LA Times article examines the history of Fed statements when rate hikes were last implemented ten years ago.
The Fed used the phrase “considerable period” in August 2003 to signal its intent to maintain the then current rates into the foreseeable future. By the time the Fed dropped that phrase from its statements in 2004, four years had passed since the last interest rate hike. The rate hike came five months after the phrase was dropped from the Fed’s policy statements.
The article suggests that if the Fed follows the course taken ten years ago, the first rate hike may occur next June, and incremental increases of 25 basis points will be implemented until the historic rate of 3.75% is reached at the end of 2017. While a 3.75% rate would be a welcomed sight for preneed trusts, it may not be enough to offset the rate at which the cost to perform contracts has risen. And in the meantime, the incremental interest rate hikes will erode the value of long term bonds issued since 2008. New trusts, or trusts which were forced to ‘start over’ subsequent to 2008, will be the most vulnerable to market value erosion.
When Missouri re-wrote its preneed law in 2009, drastic changes to trusting requirements caused many funeral homes to establish new trusts. For IFDA members who left their master trust, those trusts were liquidated before transfer. To the extent these trusts sought investment return without assuming any equity risks, long term bonds were their only course of action.
Funeral homes with preneed funds parked in long term bonds need to pay heed to the subtle warning given by the Fed. Your preneed portfolio be vulnerable to market value losses as the Fed implements incremental rate hikes. So long as the rate hikes are incremental, trusts will have time to adjust their investment policies to minimize or avoid market value erosion.