Hot topics close
 

Understanding Interest Rates – and Why You Need to Care

It’s easy to lose sight of how interest rates impact our household finances amid a decade of tumultuous rate fluctuations. It may be tempting to write off rate increases and decreases as something you cannot nor should not react to, since it ultimately is out of your control. But to ignore interest rates is folly. What follows is a primer on interest rates and what they mean for you.

First, let’s explore what interest rates actually refer to, as well as how they rise and fall. In general terms, interest rates influence the cost of borrowing money for individuals and companies, as well as the yields we earn on such things as savings accounts and CDs. As interest rates go up, borrowers will suffer and savers will benefit. Just the opposite happens when interest rates go down. In the U.S., the Federal Reserve has control over what is known as short-term rates. For longer-term rates, such as a 10- or a 30-year U.S. Treasury note or bond, market forces like supply and demand drive the momentum.

What Goes Up …

For the better part of the past decade, the Fed kept interest rates very low in an effort to encourage borrowing and reinvigorate the economy in the wake of Great Recession. For the everyday consumer, this meant their savings accounts saw paltry returns, but it was easier for them to buy houses and cars, refinance mortgages, etc. Moreover, as the economy gained steam, consumers who had invested in the stock market saw their returns increasing, pumping more money into the economy. The benefits of low interest rates are undeniably powerful for a struggling economy, but the fear is they can ultimately create market distortions, leading to bubbles, an overheated economy and/or hyperinflation.

As we reached 2018, however, the Fed started to steadily increase short-term rates to keep the economy from overheating, and just as importantly, provide room to lower rates in the event of a future recession. The intended result — to slow down the amount of money flowing into the economy, thus keeping inflation from spiraling out of control — rewarded savers with CDs and money market accounts and made it less attractive for consumers to finance major purchases with debt.

In 2019, the tide turned again — and fairly quickly. Fears of global trade wars and slowing economies has caused the Fed to rethink rate increases, leading to a rate cut in July for the first time since the Great Recession. This was followed up with another cut on Sept. 18. Consider how this change has affected the 10-year U.S. Treasury note (a common benchmark for economic health). In November 2018, it topped out at 3.24%, the highest it had been since 2011. As of August 2019, however, the 10-year note was yielding approximately 1.7%. For savers, the result is somewhat unkind, but for borrowers, it is once again a tailwind helping the household.

A Sign of a Recession

It is also important to note we are currently experiencing what is called an inverted yield curve. This occurs when a short-term U.S. Treasury bill (three to six months) yields more than a longer term U.S. Treasury note (three to five years). Why is that important? An inverted yield curve often, but not always, occurs just before a recession. Some economists consider the inverted yield curve to be a flashing warning signal. Others explain this inverted yield curve may be different this time, and not necessarily a harbinger of an imminent recession.

Which of course reminds us of the two most important words when it comes to predicting the future: Nobody knows.

What Savers and Borrowers Should be Doing

For the time being, it is reasonable to expect a downward or flat trend in interest rates. If you are looking to buy a house or car, that’s good news for you. If you have a current mortgage with an interest rate over 4%, it may be time to consider a refinance. A flat and falling environment is also kind to bond mutual fund investors, many of whom have seen very attractive returns this year. For CD and deposit accounts, the trend will continue downward.

We should all remind ourselves recessions have not been eliminated; we just haven’t experienced one in 10 years. Whether it starts today or in two years, stay attuned to the rate environment and understand its impact on your financial household.

Similar news
  • Federal Reserve says 'full range of tools' in play to counter pandemic
  • US unemployment rate soars to post-WWII record high: Federal Reserve
  • US unemployment rate soars to post-WW2 record high: Fed Reserve
  • Quantitative Easing Is Dead, Long Live Quantitative Easing
  •  
  • Quantitative Easing Is Dead, Long Live Quantitative Easing
  • The Finance 202: Fed's Powell signals Congress needs to do more to ease grim economic forecast
  • Fed Leaves Rates Unchanged and Projects Years of High Unemployment
  • Fed vows to support U.S. economy's 'long road' to recovery after dire 2020
  • Fed vows to support US economy's 'long road' to recovery after dire 2020
  • The Federal Reserve has a grim outlook for the economy in 2020.
  • EM shares, currencies gain as markets turn focus to Fed
  • World Shares, US Futures Rise Ahead of Fed Policy Decision
  • Fed officials see risk in the re-open economy that is very early, but they recognize the need for action
  • BlackRock won't charge the New York Fed fees on ETFs included in its bond-buying program
  • Federal Reserve Taps BlackRock to Purchase Bonds for the Government
  • Fed taps BlackRock to buy bonds for the US government
  • 'Nationalisation' of bond markets helps calm nerves
  • Markets rebound as policymakers further boost liquidity
  •  
  • Fed starts emergency program to aid money market mutual funds
  • Fed Starts Emergency Program to Aid Money Market Funds