With the Federal Open Market Committee (FOMC) meeting this week, I thought this would be a good time to talk about interest rates and how they affect certain sectors of our economy. Right now, rates are near historic lows and it looks like they might be heading even lower. The trade wars and tariffs have had a detrimental effect on the U.S. economy, slowing down commerce in both directions. One way to combat this problem is to lower interest rates to spur growth. Consensus is that the FOMC will be doing just that at either this meeting or the next.
So, knowing that lower rates are probably going to be hanging around for a while, here’s how they affect various aspects of our economy:
Lower Mortgage Rates
This helps people looking to refinance their existing mortgages and for first time home buyers. It also helps home builders, appliance manufacturers, and everyone else included in the housing industry.
Reduced Borrowing Costs for Companies
Corporations can borrow money at lower rates. This lowers their interest expense which makes them more profitable and frees up cash to hire more people, expand their businesses, etc.
Investment More Likely In Riskier Assets
When interest rates are low, investors tend to stray from the safety of government bonds to more riskier assets to make a better return on their money. Currently, the 10 year US Treasury bond is yielding 2.07%. As an investor, this makes me want to put my money in something that can get me a better return than 2% per year, such as stocks, real estate, or high yield bonds.
Conservative Investors Get Hurt
Risk averse investors get punished in a low interest rate environment because savings rates for money markets, CDs, and savings accounts drop.
Pensioners, Social Security Recipients Lose Their Annual Raises
People that rely on pensions, social security, and other fixed income sources are less likely to get any cost of living increases when interest rates stay low.
U.S. Dollar Devalues
The dollar typically drops in value in relation to other currencies when interest rates stay low. This makes our exports cheaper abroad but costs more for us to import goods.
As an investment adviser, all things being equal, I’d rather have lower interest rates than higher. I feel low rates put a “floor” under stock prices, meaning stock market drops won’t be as bad and won’t last as long versus when interest rates are higher.
Joe Baker, CFP®
Baker Asset Management, LLC
joebaker@bakerassetmanagement.com
