Why the worries about interest rates?

[MichealKnight]

I know the obvious reason why people want interest rates low, I get it.

BUT....I don't understand the fear and whining over potential "tapering" and rate hikes.

1st off, who thought that rates would *never* go up? Why are so many people and financial media types acting worried?

Also, pre-covid. Just a day before Covid. A week. before Covid. Months and years before Covid - -rates were considerably HIGHER than today....and, wasn't unemployment nice and low? Weren't homes selling in a rather timely manner? New Car sales were consistently over 16 million per year. Stocks were rising just fine if you look at the average mainstream mutual funds or S/P or Dow.

So now, what gives? Why all of a sudden, we can't gradually go back to 2018 interest rates?

Would love to hear any thoughts, thanks

 

[RobbieB]

I'm not worried about them. If they go up my bonds will go down and probably my equities. That's what always happens eh?

 

[Markola]

Not worried either, should this era of absurdly low, almost deflationary interest rates return to something approaching normal, in historic terms.

The average duration of the bonds in my index fund is about 8 years, meaning that about half of them would convert into plump, higher paying piggies after just four years, and virtually all of them would be converted into big, fat higher-rate hogs after just 8 years.

Increasing interest rates would also, presumably, reflect a growing economy such that the Fed would be confident enough to raise rates. Therefore, my stock index funds ought to be doing just fine, too.

 

[VanWinkle]

I've got all of my bonds in my IRA which I will start RMDs in 5 years. Duration of my bonds is right at 5 years, but I will begin moving some to shorter duration as needed for RMDs. I'm not worried about interest rates as the new bonds in the fund will mirror the higher yields/interest rates.

 

[GenXguy]

I'm not worried about interest rates going up, I WANT them to go up.

 

[Aerides]

who is worried about them? I don't watch or listen to any financial punditry or silliness.

In general, there is a line of thought that says if we could all get a solid 5+% in CD's we'd drop Vanguard and plonk our cash into savings and disinvest from the markets. But, while...sure ok, it's not like that's going to happen in a vacuum, or overnight.

The Fed is nothing if not deliberate and incremental, moving in quarters and halves, then seeing where the wind blows.

 

[Montecfo]

It's pretty simple: higher rates raise costs for businesses we invest in.

AND, equities and bonds are ultimately valued based on discounted future cash flows. Higher interest rates mean those future cash flows worth less presently. So they reduce the value of bonds and equities. Which lowers everyone's net worth. Kind of a big deal.

Now, it does not mean stocks can't continue to to rise, but it creates a headwind. I am just hoping it's not a really stiff headwind.

But I would not call it a worry for me. It is simply a market condition to plan for.

 

[audreyh1]

Lots of Wall Street people scream and cry and have tantrums at any hint of interest rates rising (or normalizing in this case). Basically it’s taking candy from the babies…….

They got used to all the candy and feel entitled to it.

 

[triangle]

Like @Montecfo notes, the current stock price of companies is based on their earnings when compared to the discount rate. So higher rates would push down stock values. Many investors would put a larger percentage of their assets in bonds or cash if they could get a higher and safer bond/interest rate. Something that is above the rate of inflation. Then there is the obvious cost of borrowing. Many companies have relatively high levels of debt, a lot of which will be need to be refinanced in the coming years which will strain future profits as rates increase.

But I think some professional money people, like the types interviewed on CNBC are not that worried about the markets if there is a gradual increase in rates and they stay reasonably low (2-ish range?) as long as the moves are well telegraphed so that everyone can adjust. I think it may be the near term traders who are the most worried. And the people trying to gain some edge and get ahead of the future move in interest rate which can in turn trigger big moves as the algos and herd reacts. In that sense I agree with you that the worry is probably overblown.

 

[youbet]

Not worried either, should this era of absurdly low, almost deflationary interest rates return to something approaching normal, in historic terms. o.

There has been nothing “almost deflationary” about the current low interest rates.

 

[MichealKnight]

Thanks

'But I think some professional money people, like the types interviewed on CNBC are not that worried about the markets if there is a gradual increase in rates and they stay reasonably low (2-ish range?) as long as the moves are well telegraphed so that everyone can adjust. I think it may be the near term traders who are the most worried. And the people trying to gain some edge and get ahead of the future move in interest rate which can in turn trigger big moves as the algos and herd reacts. In that sense I agree with you that the worry is probably overblown.[/QUOTE]"

Perhaps I'm wishful thinking, as I'm in the infancy of early retirement. But I put stock in the fact that - business was darn good at pre-Covid interest rates and that it could be fine again - barring extremes like Covid, 9/11, etc. I think business, and the marketplace evolves - be it higher prices, layoffs, streamlining, etc because in the end, corporate America is there to make profits, and grow profits. '

Big Ups and Big Downs aside - I wonder about the average over the years vis a vis my nest egg and hopefully "making it" being retired at 46. I think of diversifying into many blue-chip stocks - good brands, good histories, good prospects and mutual funds that do the same with stocks and bonds. And over the long term - I think that 1.5% dividends, 2.5% inflation, 2.0% GDP -- makes for a 6% return for stocks. (My plans are based on a 4.9% annualized nominal return, with yearly expense bumps of 3%) So when I look at the dividend +GDP+inflation being 6%, and the historical averages of 8-10%....I keep telling myself that 5% is realistic over the long haul - -and 6% would be absolutely a treat.

For the next few decdes- sure, population growth in America might slow ---but it's still growing. World population - will still grow. I think think that it means more people will drink Cokes, buy phones, use computers, shop for clothes and cars and toothpaste and they'll rent an d buy houses, and - they'll need doctors and medicine and I gotta believe that but for occasional scandals and stupidity - - these corporations know how to capitalize on all of that.

I'm 6 months into R/E. It happened earlier than I wanted. So sadly - I look at my plans and portfolios -- - round the clock and I know that eventually , I need to just enjoy life, find an activity, and sort of leave it the heck alone.

I have 1 rental house now - I'd like to ultimately have 5. It's so high right now - so I'm being patient and am hoping to buy 2 - -and then seeing what happens with housing markets. Hopefully - by next year I'll have one year under my belt, I'll see monthly rents coming in - -and at that point my goal is to play some poker, take some walks, maybe a few mini-trips and let hopefully the market treat me 70% as good as it treated people in the past century.

 

[The Cosmic Avenger]

I'm worried about it, because I'd like to buy/build a vacation home in about 3-4 years! But hey, if interest rates are sky high then, maybe I'll just pay cash.

 

[ShokWaveRider]

I'm not worried about interest rates going up, I WANT them to go up.

Me too.

 

[MichealKnight]

There could be perks

Me too.

I don't think they'll go to the highs of recent history - - our culture IMO seeks to coddle spenders and consumers, on the backs of savers.

I look back at 6% CD rates in the late 90s. Wow - if I could get 6% in CDs today...I think I'd be almost 0% equities and no risk.

 

[pb4uski]

I find the gyrations and hand wringing of the stock market whenever there is a hint of increased interest rates from today's historically very low interest rate to be very amusing... it's not like that we haven't had very robust economies and stock market returns during period of moderate interest rates in the past.

I sometimes wonder if the stock markets antics when higher interest rates are looking likely is just for the benefit of the Fed.

 

[Markola]

Well, the business press has to have SOME boogeyman-phantom-menace on the horizon to write about, and they get us to pay attention by breathlessly warning how it’s the end of the world as we know it. But I feel fine.

 

[Chuckanut]

The way I figure it, rates could rise by 3% overall and we would still be in the normal range. Imagine a 6% 30 year fixed mortgage!! Well, yes I can, very easily.

 

[daylatedollarshort]

I have more of an interest in real interest rates. Historically, they seem to have average around 2%. When we first started out retirement, I could get TIPS at 2 - 3% above inflation. We just decided then, eh, good enough with the safety of Treasuries and no sequence of return issues.

For a 40 year retirement, even a 0% real rate would provide 2.5% safe withdrawal rate. Now we can't even get 0% on new TIPS purchases, so there goes that plan going forward. If low real rates keep up, I'll have to start looking into other options like preferred shares when TIPS ladders mature, and max out the I-bond purchases to the limit each year.

 

[Spock]

Look at the shear magnitude of debt today vs. back when rates were "normal".
Taking the gov as an example of an entity that only rolls-over/refinances and never actually retires debt (High Yield unprofitable companies are another): how does such an org stay afloat with massive debt and higher interest expenses?

The last time the Fed attempted to taper asset purchases we had the so called "taper tantrum".
The last time the Fed attempted to reduce it's balance sheet stocks tanked, the Fed abandoned plans to normalize and restarted QE.
I've lots track of the debt increase since those past events... what are they now... 50% higher in the last 2-3 years?
Every time the Fed hints at exiting, markets become "disorderly".
As was alluded to in previous posts, the market is driving the Fed instead of the other way around.

You'll have to google things like "Mohamed El-Erian no exit" (the guy from PIMCO and Allianz) yourself for their arguments as to why rates can't be allowed to rise.

 

[Montecfo]

I don't think they'll go to the highs of recent history - - our culture IMO seeks to coddle spenders and consumers, on the backs of savers.

I look back at 6% CD rates in the late 90s. Wow - if I could get 6% in CDs today...I think I'd be almost 0% equities and no risk.

Well, that and we are in what at it's core is a very slow growing economy. It is really hard to sustain 4, 5, or 6 percent interest rates when your population growth 1-2 percent.

So I do not think rates can rise that much.

 

[Dtail]

Me too.

Me three even if temporary just to lock in those higher rates.

 

[Koolau]

No expert, but isn't the FED primarily there to "manage" inflation? They have few tools - raising rates being (IIRC) the primary one. Pumping or not pumping liquidity by printing (or not printing) is the other tool as I recall. Don't we have inflation? It would make sense the FED would do what the FED does when inflation begins to emerge. Also (in theory) the FED isn't primarily concerned with stock prices - "in theory." Just sayin' as YMMV. I agree that the market is trying to cow the FED into NOT using its tools. It's the inmates running the asylum - again.

 

[UnrealizedPotential]

My understanding is that tapering is the first step towards a rate hike and that takes a while to play out in the market and then comes the rate hikes. But the stock market is forward looking and so anticipates slower growth. When factoring in tapering and rate hikes and its effect on the market a correction can occur in this scenario.

When one adds the rich valuation in stocks and the growing calls for a correction that is overdue, investors can get nervous. But to me , the worry about interest rates increasing means capital costs increasing which means slower growth.

 

[Markola]

No expert, but isn't the FED primarily there to "manage" inflation? .

Inflation has been a prominent focus in recent decades but the Fed was created to protect banks from their own greed and stupidity, and thus the rest of us. It keeps keeps the financial system liquid and loaning to the rest of the economy, keeping us in business through the natural economic cycles. It protects democracy by shaving off the harshest edges of an untrammeled, unregulated free market capitalist system, which, before regulation, was regularly so harsh to average voters’ lives in various panics and depressions that the public might have been susceptible to voting in some kind of totalitarian, fully-planned economy, and other disasters.

 

[ownyourfuture]

Very interesting thread.

Here's a related question.
When I bought my first home on July 1, 1994, a 30 year fixed was 9.25%
adjustable 6.25%.

I had zero real estate experience up to that point. Every single person I asked told me to lock in the 9.25%. Luckily, I went full on contrarian & chose the adjustable.

Someone can correct me if I'm wrong, but if memory serves, the economy was doing just fine.

Why is it that 27 years later, with rates about 1/3 what they were then, do we have a federal reserve that seems terrified to raise interest rates a measly 25 basis points ?

What does that say about the underlying economy ?