A Closer Look at Interest Rates
The Federal Reserve (Fed) determines the rates at which U.S. banks borrow money. Their changes can produce a ripple effect across the entire economy. As the Fed continues to keep interest rates low for the foreseeable future, investors need to reexamine their portfolios and return expectations. Investors should take note of interest rates as they can have both a positive and negative effect on markets. Central banks often move interest rates in response to economic activity. Historically, rates have been raised when the economy is excessively strong and reduced when the economy is slow.
The all-time low for the Fed Funds Rate is effectively zero. The Fed has only lowered their rate to a range of 0% to 0.25% twice. The first time, during the financial crisis of 2008. The second and most recent lowering was this past March to help lessen the blow of multi-state lockdowns and millions of job losses. After the 2008 lowering, the Fed did not start raising their rate until December 2015. (Source: The Balance, 3/30/20) Low interest rates can make the yields on bonds less attractive to investors that need and seek returns. With interest rates at or near all-time lows, many investors cannot generate income or meet their long-term goals with a full portfolio of cash and bonds.
U.S. Treasury Yields
The 10-year U.S. Treasury enjoys a reputation as a “safer” investment for portfolios. The 10-year U.S. Treasury yield on Wednesday, July 22, was 0.60%, continuing its trend of hitting all-time lows since March of this year. For perspective, on July 22, 2019, it was yielding 2.08%. On August 1, in response to an overnight 10-year Treasury yield low of approximately 0.52%, Jim Reid, Deutsche Bank’s chief credit strategist said that, “The U.S. has been through depressions, deflations, wars, restrictive gold standard regimes, market crashes and many other major events and never before have we seen yields so low back to when the Founding Fathers formed the country."
With speculation that interest rates will remain low for quite a while, some investors are looking at the slightly better returns of 20-year and 30-year rates, which were also at historically low rates of 1.08- 1.29%. (Source: MarketWatch, August 1, 2020) Since the initial outbreak of the coronavirus in China on December 31, 2019, the 10-year rate has fallen more than 100 basis points. (Source: U.S. Department of Treasury, July 2020) In an effort to stimulate the economy, the Fed also implied in their statement after their two-day meeting in July that they may also adjust its purchases of Treasury bonds and mortgage-backed securities, which may bring long-term rates even lower. (Source: usatoday.com 7/29/20)
Historically Low Mortgage Rates
Interest rates for 30-year mortgages can be linked with Treasury yields. Since November 2018, the 30-year mortgage rate has dropped by 2 percentage points, down to 2.98%. This is the lowest level it has ever been since Freddie Mac began tracking mortgage rates in 1971. The 15-year fixed mortgage rate fell to 2.48% in July. (Source: Washingtonpost.com 7/16/20) Many borrowers are taking advantage of these record lows and banks are seeing an uptick in home purchasing and refinances.
While many businesses can benefit from borrowing money at lower interest rates, historically, when interest rates are lowered, investors could see:
Bond prices rising
Potential stock market rises
Lower interest rates on savings accounts & CDs
Lower mortgage rates
Conversely, when interest rates rise, investors should be watchful for:
Bond prices falling
Potential stock market declines
Higher interest rates on savings accounts & CDs
Mortgage rates rising
With interest rates at historic lows, many investors subscribe to TINA, meaning There Is No Alternative to stocks – or that equities need to be heavily considered for an investor’s portfolio. For investors looking for more income or retirement cash flow, today’s bond yields are not providing equitable returns. While it is tempting to invest in more higher yielding stocks, equities today are not cheap and even the savviest of investors need to be considerate of risk...
To read the rest of our special edition on Interest Rates - sign up for our Newsletter Here!