Interest rates remain stubbornly low, which has been great news for borrowers, and bad news for savers. Many of us fall into both categories; we love the low rates for mortgages and car loans, and loath them because of the drag on savings and investments. This all started during the Great Recession, but the persistence has some confused and frustrated.
The country was in dire straits during the Great Recession of 2007, and the Federal Reserve or “Fed” did what it does best – printing money on a massive scale to help stop the bleeding. They did this by buying lots and lots of bonds, and when they buy bonds they pay with cash that didn’t exist before. This was done to the tune of around $3 trillion dollars, which was enormous even in the world of big numbers. A popular tongue-in-cheek analogy at the time was “They’re dropping money out of helicopters.”
Typically, when lots of newly “printed” money comes into the economy and the economy recovers, which it did some time ago, inflation begins to surge. This leads the Fed to begin selling the bonds it had purchased, which soaks up the printed money by replacing the cash with the bonds, undoing what it did essentially. When the Fed sells a bond, the cash it receives from the buyer is effectively destroyed.
Now we are in a period of low unemployment, the stock market has recovered (and then some), but inflation remains low. This stubborn and unexpectedly low inflation is where we are today. And so, the Fed has not been able to sell those bonds and soak up all of the money “printed” during the crisis.
At this point the continued low rates are confusing many people, and the subject of much debate. Some feel it reflects poor expectations of long-term growth, while some blame it on Europe, as they buy U.S. bonds because rates there are even lower, and some blame it on the Fed itself. What will happen and what does this mean for most people?
“This time it’s different” is attributed to John Templeton as the four most dangerous or expensive words in the English language. However long it takes, markets tend to return to long term averages.
When this occurs, it will affect different markets in different ways. As rates rise, mortgage and loan rates will increase, the price of bonds will decrease, and stock prices will experience downward pressure. Home prices will not rise as quickly because it costs more to borrow money, but rates on savings accounts and CDs will go up. However, it doesn’t have to be all bad news.
If you have recently refinanced your home, then you should be locked in for a long time. The rates on bank accounts will improve. And with a disciplined, consistent approach to long-term investing, portfolios should weather the storm.
After all, if interest rates are increasing they keep inflation under control, and nobody likes inflation! That also means the U.S. economy is gaining strength, which is always good news.