The era of super-low interest rates might be ending. What’s in it for you?
Financial markets have sent a forceful message that the era of super-low interest rates is coming to a close.
Since President-elect Donald Trump’s surprising election victory this month, financial markets have sent a forceful message that the era of super-low interest rates is coming to a close.
Mortgage rates have shot up. Bond yields have jumped to their highest levels in a year. And the dollar has surged against other major currencies to values unseen in more than a decade.
Those developments have been fueled by expectations of stronger economic growth and higher inflation from Trump’s promises to cut business taxes, reduce regulations and increase defense and infrastructure spending.
His plans triggered a post-election stock market rally and, combined with recent solid economic data, increased expectations that the Federal Reserve would nudge up its benchmark short-term rate again next month — with more hikes to follow next year.
If rates continue to rise — a big if, analysts said, as Trump tries to turn his proposals into reality — there wold be some economic benefits. Savers would finally start getting closer to a decent return on their bank accounts and the financial system would move closer to normal after an unprecedented period of low interest rates that left investors and businesses searching for higher returns in stocks and other assets.
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But rising rates also could slow home purchases and auto sales, boost the costs of U.S. goods abroad and make it more expensive for businesses and the government to borrow, economists said.
“If you’re in the market to buy a home, it’s not so good,” Mark Zandi, chief economist at Moody’s Analytics, said of higher interest rates. “It will cost more for a car loan. If you’re an exporter, all else being equal, it’s not good.”
Here’s how rising interest rates could affect some key economic activities and sectors.
Consumer spending and borrowing
A rise in interest rates would pinch Americans with added costs as they borrow money for cars, major appliances and other items, but analysts are divided on whether that would be enough to slow the pace of consumer borrowing.
With rates at historic lows for the last eight years, U.S. household debt has been climbing back to levels not seen since the financial collapse in 2008.
Total consumer debt — including home mortgages, auto loans, student loans and credit-card debt — was $12.3 trillion as of June 30, according to the Federal Reserve Bank of New York.
Delinquency rates on those loans have continued to improve, the New York Fed said. That’s in good part because the 2008 collapse prompted many Americans to pay off debt, refinance their homes and otherwise shore up their personal finances.
Still, even a slight increase in rates could disrupt the pace of borrowing, partly because the low rates had enabled many Americans to qualify for loans that otherwise would have been out of reach, said Scott McGann, a finance lecturer at San Diego State University’s business school.
“People making $35,000 to $40,000 a year are driving luxury sedans because rates were so low,” he said.
But Greg McBride, chief financial analyst at financial information website Bankrate.com, said consumers won’t notice the impact of a Fed rate hike next month. Each increase in the central bank’s benchmark federal funds rate usually is just 0.25 percentage point.
“It has an inconsequential effect on household budgets and zero impact on affordability,” adding only a few dollars to an average monthly car payment, McBride said.
Trump is the wild card. If his policies push rates steadily higher in the next two years, that could give consumers serious pause about borrowing more, analysts said.
-- James F. Peltz
Real estate
For prospective home buyers, higher interest rates already are here.
Mortgage rates tend to rise and fall along with the yield on 10-year Treasury notes. Those yields have jumped lately, and mortgage rates have gone along for the ride.
The week before the election, the interest rate on a standard 30-year mortgage averaged 3.54%. Two weeks later, mortgage rates had jumped to an average of 4.03%, according to government-backed mortgage buyer Freddie Mac.
The sudden increase has cooled the market for mortgage refinancing and is likely pushing some prospective home buyers to rethink how much house they can afford.
The number of customers looking to refinance loans dropped almost immediately once rates started to climb, said Dave Norris, chief revenue officer of Orange County mortgage lender LoanDepot. “Within 24 hours of a rate increase, we’ll see a drop in refinancing,” he said.
When mortgage rates are low and dropping, refinancing activity rises as homeowners look to replace higher-rate loans with cheaper ones. With rates now headed the other way, refinancing activity is expected to drop off in 2017, according to the Mortgage Bankers Assn.
Nevertheless, the group estimates an improving economy would mean more people looking to buy homes. But with somewhat higher rates, buyers will be able to afford less.
On a $450,000 mortgage — about what you’d need to borrow to buy the median California home — the difference in monthly payments since the election amounts to about $125.
Mike Fratantoni, the Mortgage Bankers Assn.’s chief economist, said he thinks rates will stay between 4% and 4.5% next year and shouldn’t crimp affordability too much.
-- James Rufus Koren
Personal investment
Rising interest rates could be a mixed bag for individual investors depending on whether they’re looking to park cash in stocks, bonds or savings accounts.
Stocks have rallied in response to Trump’s election. Financial stocks and shares in construction and building-materials companies, in particular, have surged in response to Trump’s call for lower corporate tax rates, less banking regulation and more infrastructure spending.
But with the Dow Jones industrial average hitting 19,000 for the first time ever last week, stocks are getting pricey.
As of Nov. 18, the benchmark Standard & Poor’s 500 index was trading at 24.2 times the profit of its member companies over the previous 12 months. That’s up from 23.1 a year earlier and well above the historical average of 15.5, according to the research firm Birinyi Associates.
Looking a year ahead, that ratio is expected to drop to 18.3 as corporate earnings grow under the first year of the Trump administration, meaning stocks wouldn’t be quite so expensive, Birinyi estimates.
In any case, “it’s likely the economy can sustain gradual increases in short-term interest rates, which is what’s on the mind of the Fed,” said Mitchell Weiss, a financial consultant and contributor to Credit.com. “They’re not looking to shock the economy.”
That should filter through to higher returns on savings accounts. “However, that might be just a moral victory if inflation is also moving higher,” McBride said.
In the bond market, yields on Treasury securities have shot up since Trump’s election amid speculation his policies could fuel higher inflation. The yield on the 10-year Treasury note has jumped to 2.35% from 1.57% on Sept. 1.
That makes the government bonds more attractive to new investors. But if rates keep rising, prices of those bonds would fall because their yields would now be less attractive.
John Petrides, managing director at Point View Wealth Management Inc., urged investors to spread out their risks in the face of rising rates and the Trump presidency.
“Stocks provide growth,” he said in a note to clients. “Bonds provide a ballast when equities are under pressure. Cash remains a short-term option but a long-term hostage to inflation. Don’t let upside or downside volatility derail your long-term investment goals.”
-- James F. Peltz
Business borrowing and government debt
A little more than a year ago, the Fed signaled the beginning of the end for rock-bottom interest rates by nudging up its key short-term rate after holding it near zero for seven years.
But domestic and international uncertainty, including the U.S. presidential campaign and Britain’s June vote on whether to leave the European Union, caused Fed monetary policymakers to delay additional rate hikes.
Fed Chairwoman Janet L. Yellen indicated at a congressional hearing last week that the next small hike is likely in mid-December, to between 0.5% and 0.75%. Economists expect more rate hikes in 2017, although it would take several years of increases before rates get back up to their pre-Great Recession level of about 5%.
“This period of super-super low rates is going to be replaced by a period of super-low rates,” said J.D. Foster, chief economist at the U.S. Chamber of Commerce.
The federal funds rate applies only to short-term lending between banks. But it affects other borrowing costs and has become a benchmark for consumer and business loan rates.
With rates low for so long and the economy sluggish, businesses have been holding on to their cash. They’re sitting on an estimated $1.9 trillion, so Foster said interest rate hikes initially shouldn’t affect businesses very much.
“Most of them have lots of cash…. They have no need to be borrowing a lot,” he said.
The U.S. government, however, constantly needs to borrow because it runs a budget deficit that was $590 billion in the most recent fiscal year. Rising rates mean the federal government would have to pay more to borrow, and that has some officials concerned.
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With the federal debt at about 77% of total annual economic output, “there’s not a lot of fiscal space, should a shock to the economy occur...that did require fiscal stimulus,” Yellen told lawmakers last week.
The Congressional Budget Office has forecast that interest rates would rise slowly, with the 10-year Treasury bill hitting 3.4% by the end of 2020.
Rising rates and expected growth in the federal debt would mean the government’s net interest costs would nearly triple over the next 10 years, to $712 billion, the CBO said in its most recent report in August.
-- Jim Puzzanghera
Foreign trade
Trump railed during the campaign about the nation’s large trade deficit, but rising interest rates triggered by anticipation of his economic policies could drive up that figure.
Higher interest rates in the U.S. lure investment from abroad, pushing the value of the dollar higher in comparison to the currencies of other nations.
Since the election, the Fed’s trade-weighted dollar index, which measures the value of the U.S. dollar against the currencies of major U.S. trading partners, has risen to its highest level since 2002.
Although that’s good for people traveling abroad, it’s not welcomed by U.S. businesses looking to sell products overseas and competing for sales here with foreign companies.
“That means imports are cheaper and exports are more expensive,” Zandi said. “That will weigh on the trade balance.”
If the trade deficit increases on a stronger dollar, higher interest rates could offset the anticipated stronger growth and inflation that is helping fuel the increase, Zandi said.
In the end, it could be a wash for the economy.
”The bottom line, when it’s all said and done, is the economy in theory shouldn’t be in a much different place,” Zandi said.
-- Jim Puzzanghera
Follow @JimPuzzanghera on Twitter
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