Over the past decade, the Federal Reserve has been pushing for modestly higher interest rates and inflation. To anyone following the markets or economic news, this statement is nothing new to hear. However, with higher inflation starting to build momentum, an economy that is beginning to stand on its own, and the potential of a US government spending plan, increasing interest rates may not be far behind.
Interest Rates – The 10-Year Treasury is now oscillating around 1.6%, nearly 3X higher than levels from last summer, granted that was in reaction to COVID. Historically speaking, the 10-Year rate was near 3% during the fall of 2018, while five years ago the rate was nearly the same as where we sit today. We would need to look back to before the financial crisis to see a rate north of 4%.
The Federal Reserve influences the rates of Treasury securities to reduce the severity of economic booms and busts within the US. As the economy heats up, rates increase to tamp down unsustainable growth; conversely, as the economy struggles, rates come down to stimulate borrowing and economic growth. This entire philosophy is supported by the theme of a business/economic cycle, where the economy is always doing one of two things – contracting or expanding. By reducing the peak or trough of boom/bust periods, the economy has less devastation during periods of significant contraction.
When considering interest rates’ impacts, we must consider what is going on within the economy. We know that businesses are starting to do better (some of which were never impacted by COVID). We know that inflation is starting to show itself in different sectors (some perhaps due to supply chain issues). We know that current tax rates are stimulative. We know that there was significant stimulus added to the economy from the government during COVID. And now, we are starting to also see talks of a $4 Trillion spending proposal gain support from the White House and from others, as well.
Former Federal Reserve Chair, and current US Treasury Secretary, Janet Yellen came out over the weekend supporting the spending package stating, “If we ended up with a slightly higher interest rate environment, it would actually be a plus for society’s point of view and the Fed’s point of view… we have been fighting inflation that’s too low and interest rates that are too low now for a decade.” She added that if the spending packages help to “alleviate things, then that’s not a bad thing, it’s a good thing.”
As we evaluate the current environment, if we continue to see strong economic figures, low tax rates, high consumer confidence, and government spending, we must believe increased interest rates are not far behind. So, what does that mean to our clients?
1. Borrowing will be more expensive. Prudent refinancing now should be considered on all debts. *PRUDENT is the key word here.
2. Savers may finally be rewarded. It has been a challenging environment to be holding cash.
3. Know what you own in fixed income.
Higher inflation and interest rates have been a goal now for over a decade. Even a Freshman on a college campus who has taken Intro to Economics could conclude that both should have occurred by now. To say that they are coming is easy, but whether this comes to fruition will be analyzed by many and opinions will be provided by all.