David's Financial Tips
Are Rates Going Up?
Last month I indicated that interest rates were to be the topic of discussion prior to pivoting to cybersecurity in light of the Equifax hacking case. Thus we will revisit that topic with respect to where rates are now and the general consensus of where they are heading. We have thought, and stated, many times over the last few years that we were about to experience a rise in interest rates, yet they haven’t budged.
The ten-year Treasury, a great barometer of the state of interest rates, has been in the low 2% range for many years. For proper context, this rate rose above 4% way back in 1963, briefly dropped below that level in 2003, then during the financial crisis dropped below 3% and has remained there ever since. The typical cycle of interest rates is for them to fall in times of economic contraction and to then rise again with economic expansion. We obviously had extreme economic contraction during the financial collapse, but also have had our Federal Reserve depressing interest rates further thru the process of quantitative easing. This process was essentially the Federal Reserve “printing” money to then buy bonds of varying maturities to keep interest rates down.
As of this writing, the 10 year Treasury is 2.54%, up from 2.07% just six weeks ago. There is rarely just one factor that affects these rates. The recent movement is a function of several variables; positive current and projected economic growth, the Federal Reserve starting to unwind quantitative easing, and the Federal Reserve ramping up short term interest rate hikes. We are seeing third quarter corporate profits coming in very strong, which is a positive signal for economic growth with many of the S&P 500 companies providing positive guidance for future earnings. With the Fed reversing quantitative easing, essentially reducing the demand for various types of bonds, the prices of those bonds will fall and interest rates will rise. Lastly, as the Fed increases short term interest rates in response to accelerating economic activity this leads the market to discount current prices of bonds and thus rates will rise.
We are not envisioning a scenario where your next mortgage is going to be 16% as it was back in the 70’s/80’s. But a rise in interest rates has many effects on your current asset allocation. All else being equal, rates rising too steeply will negatively impact your equity holdings as well as longer term bonds. On the flip side, it would be nice to be back in a position to be able to leave cash in a money market account earning 2-3% or the five year CD giving us 5%. Those are merely historically normal interest rates. We see rates gradually climbing thru 2018 with current economic activity remaining consistent and the Fed adhering to their schedule of rate hikes and bond sales. We will continue to closely monitor interest rate changes and endeavor to keep you in the best position with regard to whatever the upcoming market factors present.