During the month of May, the interest rate on 10 year Treasurys rose to just more than 2 percent. This has led many to wonder if our era of extraordinarily low interest rates is finally coming to an end.
While longer-term rates have risen, short-term rates are still essentially near 0. What this means is that, if you are obtaining a fixed rate mortgage, you have seen rates rise by about 0.5 percent recently, though rates on variable loans, such as home equity have been stable.
In recent years there have been periods of time where longer-term rates have briefly spiked, as they have recently, only to settle back down. While this may happen again, I do believe that we are near the end of the era of very low rates.
If someone is looking to purchase a house, you should realize that a 30-year mortgage at 4 percent is still exceptionally low on a historical basis. You may not be happy that you could have obtained that mortgage for 3.5 percent recently, but recognize that in several years mortgage rates could be 5 to 6 percent.
Likewise if someone is looking to buy longer-term bonds, yields are higher than they were a month ago. However, in a historical context they are still very low, so I believe in the future you will be able to purchase bonds with higher interest rates than currently.
For someone who has kept money in savings accounts or money market funds, the past five years have been a terrible time. Even though inflation has been relatively benign around 2 percent, earning essentially 0 on your money means your purchasing power has been dropping every year.
The recent rise in rates has only impacted longer-term yields, so returns are still virtually 0 for savings accounts. It will probably be another year before short-term interest rates will rise, and savers will realize some return. If you are saving for a major purchase, and your time horizon is short, such as a year or two, having money in a money market fund is still appropriate.
However, for other investors’ money market holdings should typically be only what you would have for an emergency fund. For retirees, it is important to recognize that someone who just turned 65 still has an average life expectancy close to 20 years. Therefore, even seniors for the most part should have some investments in stocks, and not everything in savings accounts.
Another consequence of rising interest rates would be a negative effect on our federal budget deficit. The deficit is finally coming down some this fiscal year, though it still remains high based on a historical basis. However, with very low rates the interest on the debt has not been too onerous. With rates rising the interest expense will be more significant, thus hindering our ability to reduce the deficit.
A rise in interest rates should be considered positively, in that the economy is starting to stabilize. While rates may change little or even drop modestly for a few months, they will very likely be higher looking out into the future.
Recent times have been very favorable for borrowers, but not for savers. Eventually things will change, if inflation remains near 2 percent, a normal environment would see money market yields around 2 to 3 percent, not 0, as they are currently. It still may take close to two years before the Fed raises rates close to normal levels.
For the investor, I believe it is still too soon to purchase longer-term bonds in a major way. While interest rates have risen, they are still very low on a historical basis, so I believe there will be better opportunities in the future. The stock market has performed very well this year, and appears fairly valued, so I would keep positions near normal levels.