Another upshot of this year’s presidential election is the sudden rise in interest rates. Almost overnight, rates have significantly increased. There are various theories as to why this phenomenon is happening. Bond investors seeing more signs of coming inflation, OPEC’s agreement to cut oil production, the incoming president’s policy proposals causing higher budget deficits which are inflationary, the assumption of economic growth, and increasing employment if the largest multi-national companies move their operations back to the U.S. are all at least partially true. Of course, we won’t know what actually will happen until the new president is sitting in the Oval Office and making decisions that will affect the economy.
The Federal Reserve has also gotten into the act by almost guaranteeing a one-quarter percent increase to the overnight federal funds rate in December. The Fed is cautious to a fault and usually waits until the longer-term rate changes are built into the yield curve which is currently steep. A steep yield curve means that the investor is well paid to go further out on the curve and invest for a longer term. For instance, an investor can receive an extra 0.3% to invest in a two-year U.S. Treasury Note from a one-year Treasury Bill and a full 1% into a five-year Treasury Note.
While that may sound attractive, not all investments move at the same rate. Many small investors opt to invest in bank certificates of deposit (CD) and credit union share certificates. Currently, even the best CD rates are currently less than the Treasury yields. This is unusual but not unheard of. Some financial institutions will catch up and pay a high rate to attract cash. However, most will not because gross margins at banks and credit unions have gotten so small that a small increase in CD rates can mean the difference between making money and losing money. Even when the Fed does increase the overnight rate, investors should not expect instant CD rate increases.
The downside of increased rates is that borrowers will have to pay more for their cars, homes, and credit cards. Banks wasted no time in increasing mortgage rates last month. When mortgage rates go up, home sales generally decline which means buyers aren’t bidding up prices. The net effect is that it will be more difficult to sell a home, and its equity will likely decrease which will make it less attractive to sell. Buying cars has also gotten pricier even before factoring in the borrowing rate. The average median new car price is currently just under $34,000. As a point of reference, my parents paid $28,000 for their first house in 1958.
It is hard to say whether the Fed was pressured to raise the federal funds rate by investors and the media. Higher rates do not indicate happy days are here again. As with everything else, the pendulum will swing the other way and hit some of us right in the wallet. I’ll be bobbing and weaving when that happens.