Interest Rates Remain Low ... For Now
Interest rates are still predicted to grow, but at a glacial pace.
The Federal Reserve did not raise interest rates at this month’s policy meeting even though current financial conditions would easily warrant a small hike. Market expectations over Brexit and some softening of the Chinese Yuan earlier this month caused the Fed to hold interest rates steady this month, but analysts are predicting a minor increase in interest rates may still happen in December. 1
On the upside, low interest rates over recent years have allowed the Federal Government to restructure a lot of its debt and U.S. citizens have done likewise. This is good for us as a nation, because less interest that needs to be paid means less federal and personal budget restraints. Last year, Washington’s total interest payments to service the national debt was just under $225 billion. At the same time, the federal government pulled in nearly $3.2 trillion in total revenues. So the federal government’s debt obligations represented just 7% of its income last year, down from 17% in 1995.2
Low interest rates have made bonds, including Treasury Bonds, more attractive. If you owned a long-term government bond fund, Morningstart estimates that you would have earned about 7% annually over the most recent Bull Market period beginning in 2009. By contrast, the average blue chip stock fund earned 6% a year during that same stretch, which means bond investors earned comparable returns as stock investors without taking on credit risk.3
Controversy continues over our deficit. The Baby Boomer Generation is entering the Social Security and Medicare systems over the next decade, raising concerns over how the growing financial obligation to support them will be funded in the coming decades. Chances are that we will continue to increase the deficit, and if left unchecked, we could see excess inflation and a bond market in turmoil. This could eliminate the stabilizing effect that U.S. Treasury bonds have on portfolios, and it could lead investors to depend on more risky private sector options.3
Growing interest rates will provide more control over inflation and maintain stability in the bond markets, but the increases will likely continue to be slow. In recent years, the Fed added trillions of dollars of bonds to its own portfolio to avoid a deeper and more protracted recession, and now has to unwind those holdings at the same time interest rates are increased. The goal is to accomplish both tasks without throwing the markets into disarray or driving up inflation past its preferred 2% level, and the Fed is likely to excercise a lot of caution as it navigates our currently unpredictable world economy.3
What can we look forward to when interest rates finally rise? Returns on private investments, such as Corporate Debt and Insurance products Annuities, will increase, which can benefit many investors. On the downside, it is thought that increases in private debt played a big role in the most recent stock market and real estate bubbles that led to the 2008 financial crisis, and our nation’s debt payment will also increase. 3
That suggests a slow timeline for interest rate hikes in the near future - CME Group’s FedWatch tool recently priced in about a 50% chance of a hike in December 2016.1
Citations.
1 - http://www.marketwatch.com/story/why-the-fed-wont-hike-rates-despite-having-its-ducks-in-a-row-2016-07-26
2 - http://www.annuity.com/why-interest-rates-are-low-and-will-stay-that-way/ [7/16/16]
3 - http://time.com/money/4293910/national-debt-investors/ [4/22/16]
