You may have heard about low interest rates in the newspaper, online or on the TV, but what do low interest rates really mean for the general public? Interest rates are based primarily upon the supply and demand for money. With the hope of stimulating the economy since the Great Recession, the Federal Reserve has flooded the marketplace with money via its Quantitative Easing program (dubbed “QE”), but the demand for money has simply not kept pace. Consumers and businesses have opted to save more and/or deleverage their balance sheets. What are some of the positives and negatives of low interest rates?
- Low rates allow businesses to borrow cheaply to buy equipment, hire employees, make acquisitions, pay dividends and buyback shares. These actions benefit the overall economy.
- Since mortgage rates are based upon long term U.S. Treasury Yields, they too are near historic lows. This, in turn, should encourage more first time homebuyers to purchase a home and current homeowners to refinance their mortgages at a cheaper rate, saving them money on their monthly mortgage payment. The money that is saved on the mortgage payment is like a tax break.
- Rates for cars, appliances and student loans become very attractive in a low interest rate environment. Instead of paying off these loans at once, it may be better to borrow at a low rate and invest in equities for a higher rate of return.
- Low rates hurt savers whose main focus is the preservation of capital and income, because yields on bonds, CD’s and money market instruments are very low. This acts like a hidden “tax” on those who saved and expected to receive a reasonable risk-free return on their investments.
- Asset prices could be artificially inflated because many investors could turn to higher yield assets such as Real Estate Investment Trusts (REITs) and Master Limited Partnerships (MLPs). While a “bubble” isn’t likely in either of these industries, investors see them as a substitute to low yielding bonds, thus driving their prices higher than they maybe should be.
- Banks and insurance companies are also negatively affected by low interest. Insurance companies invest their assets long-term with the assumption of higher rates on their capital. Banks can suffer as their “net interest” margin, or the spread between what they lend funds at and interest they must pay on deposits is compressed. Interest rates can stay low for a long time and they need a catalyst to move higher (such as the demand for money increasing due to increased economic activity and or the supply of money decreasing).
While the positives and negatives of a low interest rate may not be obvious, they affect most everyone. Let Carnegie Investment Counsel be your guide when it comes to investing in a low interest rate environment.
Research Analyst/Portfolio Management Assistant