5 Things Low Interest Rates Tell Us

 

5 Things Low Interest Rates Tell Us

 

On Friday, July 5th the 10 year US Treasury rate hit a historic all time low. The yield bottomed out at 1.357%. Here is what we can learn from our “low-interest-rate-world:”

 

Democracy rules

The United States is still the safe haven in times of financial uncertainty. The uncertainty and surprise of the Brexit vote on June 23 led to a flight to quality for investors. As much as the US economy is impugned, it is still where the world parks its money for security.

 

Supply and Demand

As prices for bonds rise, yields fall. When there are not enough US bonds to satisfy the need for safety, the yield produced by bonds declines. The scarcer the bonds, the lower the interest rate required by the buyer.

 

Growth is slow

In a robust and growing economy, interest rates typically rise as the cost of capital rises. When growth is slow, there is less need for capital for business expansion and acquisition of assets. Interest rates are typically low in this situation.

 

Real estate should be booming

When the cost of capital is this low, real estate should have a tailwind and thrive. Owners are able to leverage real estate by borrowing at low levels thereby reducing the cost of ownership. The more one has to pay for the cost of borrowing, the less they can pay for real estate.

 

Yield Curve

The yield curve represents the relationship between interest rates on bonds that have different maturities, but equal credit quality. Normally, bonds with longer maturities have higher interest rates than bonds with shorter maturities. A flat yield curve indicates that investors are not being compensated for the additional risk involved in longer-maturity bonds. A flat yield curve can be a precursor to a slowing economy or a recession. It could also be attributed to a flight to quality (see point #1). While our yield curve isn’t flat, the short portion remains anchored well under 1% and the longer portion simply does not produce a yield that can be justified by the risks associated with maturities of 10-30 years.

 

Gene McManus, CPA, CFP
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