Are Interest Rates Heading Towards to 10 Percent or Higher

Posted in: Ideas in Finance

Are Interest Rates Heading Towards 10% (or Higher)?

It looks as though interest rates have bottomed out and have started a long march higher. If we look at the yield on the 10-year US Treasury bond, courtesy of the Federal Reserve Bank of St Louis, we can see the whole story. Interest rates went on a long upward swing from the early 1960s through to 1980. Then began the long downtrend that has been all that many people have ever known. Interest rates hit bottom in 2020 and have been heading higher since. This has very significant implications.

During the long downswing, 1980 to 2020, from 16% to almost 0%, what happened to asset prices? Houses? Shares? They experienced a long upswing, of course. In fact, in 1980, interest rates were at their peak while stocks were historically cheap. As interest rates fell, stock prices rose. And rose. And rose. This has been all that many people have ever known. And now, in all likelihood, it’s over. With around 5% available on risk-free assets, and potentially more in future, what does that do to the demand for riskier assets like commercial and residential property and shares? Why take the risk on a company with an expected return of 6% when 5% is available without the volatility? Why take a risk on crypto? Why embrace the uncertainty of an investment property? Why accept a dividend yield of 3%? Is gold worth owning given it doesn’t pay interest and interest rates are rising? The art of investment decision-making is suddenly more complex. The answers to these questions are no longer as straightforward as they were for a moment.

While this might only be the beginning, we note just how different 5% is from 0%. It’s a very big change at the margin, even though 5% is still a relatively low rate of interest. This has started to cause turmoil that the average investor possibly hasn’t even noticed yet. The flow of money in and out of individual assets and asset classes has become a little more dramatic. Some sectors boom; others slump. Some continue to move upwards as money flows in passively, automatically. But will it last? Calculations are different than they were just a few years ago, or for most of the past 40 years. We rode the great downswing in interest rates. The question is whether the great upswing will be a wild ride. If it’s any comfort, from the level we find ourselves at now to 16% is something that people lived through back in 1962 to 1980. They survived, but it wasn’t always easy. During the long downswing in interest rates, the consequences of poor decisions were not as harsh. Many a sin could be forgiven. A period of rising interest rates is not so forgiving. One will need one’s wits.

Discussion Questions

Are interest rates going to 10%? What arguments, apart from history, can be brought to bear for and against the idea?

Are Interest Rates Heading Towards 10% (or Higher)?

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