Why Interest Rates May Not Rise Quickly, or Much at All

Why Interest Rates May Not Rise Quickly, or Much at All

In response to this article cautioning against buying long-term municipal bonds, I wanted to outline some reasons that interest rates may rise slowly, or not much at all. Here are some items that also need to be considered when factoring in whether to invest in municipal bonds:

Global interest rates are incredibly low.  The market for securities becomes more global every day and investors worldwide have a choice between buying bonds almost anywhere in the world with low transaction costs.  So if interest rates in Germany and Japan stay minuscule, it is unlikely that Uncle Sam is going to pay so much more.

Economic growth is likely to remain subdued.  Demographics are destiny, and we have an aging workforce and are pretty close to full employment.  Economic growth is largely based on two factors – size of the workforce and productivity growth.  The workforce can get a little bigger, but if GDP growth was under 3% when unemployment went from 10% to 5%, how is it going to rise above 3% going forward?  Also, in a service oriented economy there are limits to how productive we can become.  What tools are making us more efficient at our jobs that don’t eliminate workers and reduce the size of the workforce?

An aging population means people need investment income.  Ten thousand baby boomers turn 65 every day, and they will need income in retirement beyond what they are receiving from Social Security and pension.  Bonds provide a more reliable source of income than stocks, and despite low rates they also offer a higher rate of income.

The stock market is incredibly expensive.  Using long-term valuation measures such as Shiller - PE and stock market capitalization to GDP, investors are paying a very high price for stocks.  If earnings disappoint, some money will come out of stocks and likely into bonds, keeping a lid on rates.

The budget deficit is going to rise, limiting fiscal stimulus.  The Federal Reserve already has a massive balance sheet of bonds and the interest they earn gets paid to the Treasury Department.  As those bonds mature the Treasury gets less income, increasing the deficit.  Then consider increased Social Security and Medicare benefits, and the impact of rates that have already risen nearly 1%, and the ability of our government to lower taxes or increase spending to stimulate economic growth become severely compromised.

Short-term rates may stay fairly low.  The Fed has been extremely cautious in raising rates, largely because they don’t see much inflation or wage growth.  Even if they do raise rates 4 times or 1% over the next 2 years, the longer end of the yield curve may not move up nearly as much as short-term rates, as has been the history during periods of Fed tightening.

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Securities offered through Kestra Investment Services, LLC.,(Kestra IS) member FINRA/SIPC.  Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS.  J Matrik Wealth Management is not affiliated with Kestra IS, Kestra AS, or Five Star Professional.

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