Category: Investments

Author: Tim Courtney

Low Interest Rate Impact on Investors

Date: 06/19/20

Last week, the Federal Reserve announced plans to keep interest rates near zero through 2021 and possibly 2022.1 At least in the near term, low interest rates are here to stay.


The last time the Fed made a systematic attempt at a return to more normal rate levels, it resulted in bond markets and stock markets throwing a tantrum. The Federal Funds rate increased four times in 20182, which sparked an inverted yield curve3 and a 20% plunge in the market.4 The markets were predicting bad times ahead but were ultimately wrong and, in fact, growth continued through 2019 and into 2020. Unfortunately for savers, the Fed retreated and lowered rates in spite of growth in 2019.5  Finally, in 2020, rates were set effectively at zero5, mostly as a result of the coronavirus.


The Fed has now shown that it wants to avoid agitating markets at almost all costs. Raising rates or pulling back on asset purchases they have committed to would almost certainly draw ire from certain investors. While the Fed’s actions will no doubt be helpful during an economic recovery, it has not turned out to be a policy that spurred impressive growth in Japan and Europe.6 Even so, low rates appear to be here for quite a while.


That said, what does this mean for investors moving forward?


First, we think earning real after-tax returns on bonds, bank certificate of deposits and other fixed income investments will be very difficult. We will probably see negative real after-tax returns on several kinds of these assets. This puts pressure on other assets in a diversified portfolio, such as real estate and stocks, to capture growth. Fixed income investors are left with two choices: hold low-yielding assets while hoping interest rates and inflation move even lower, or move into higher-risk assets to find better returns.


Inflation is another risk investors face. Many estimates are for prices to actually fall in 2020 due to the recession.7 The global decrease in demand for products and services due to the coronavirus crisis and resulting economic shutdowns puts the U.S. more at immediate risk for deflation.8


However, the more we continue to introduce economic stimulus programs and push trillions of additional dollars into the economy9, the more likely inflation may reveal itself to be a major risk again. We’ve seen this before, after World War II when the Fed intentionally kept interest rates low and let inflation run higher.10 This made it much easier for the U.S. to pay back debt from the war. We shouldn’t be surprised if a similar scenario plays out over the next many years.


Sources:
1. CNBC.com (6/10/20) -- Fed sees interest rates staying near zero through 2022, GDP bouncing to 5% next year
2. CNN Business (12/20/18) -- Federal Reserve raises rates despite signs of economic softening
3. Reuters (2/22/19) -- Flattening U.S. yield curve in late 2018 'flashing red' on economy: Fed's Williams
4. Yahoo! Finance (data as of 6/18/20) -- S&P 500
5. Federal Reserve (data as of 6/18/20) -- FOMC's target federal funds rate or range, change (basis points) and level
6. CNBC.com (6/11/20) -- Do negative interest rates work? Economists can’t agree on how effective the policy is
7. The Balance (6/15/20) -- Current US inflation rate statistics and news
8. Investopedia (6/25/19) -- The dangers of deflation
9. CNBC.com (6/12/20) -- Additional stimulus legislation may be coming. Here’s what could be in it
10. US Inflation Calculator (data as of 6/18/20) -- Historical inflation rates: 1914-2020


The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 9.9 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 3.4 trillion of this total. The index includes 500 leading companies and covers approximately 80% of available market capitalization.

 

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About the author

4054781971

tcourtney@exencialwealth.com

Oklahoma City, Ok

Chief Investment Officer

Tim Courtney serves as Chief Investment Officer of Exencial Wealth Advisors and chairs the investment committee. He attained the Certified Investment Management Analyst (CIMA) designation in 2005 a... CLICK HERE TO READ MORE