Higher for Longer Interest Rates?
It has taken over a year and a half for interest rates to rise on the long end (over 5-year maturities). That time looks like it is here. We have had an inverted yield curve, where short term rates are higher than long term. Just in the last few weeks long term rates have ticked up leveling the curve. Normally long-term rates are higher than short term. Lenders just don’t have as much risk loaning money for shorter periods of time, so they usually demand a lower interest rate.
Normality is usually a good thing for business. Lenders are happy to charge higher interest rates for lending money for longer periods. Businesses can adjust to paying higher rates by spending less or charging more. Depending on their market, that is usually what will happen. Most big business’ CEO’s biggest obstacle is needing some assurance that they can make long term plans. They want to know that either borrowing costs or regulatory environments will not torpedo.
This just might be the point where businesses can really feel confident that rates are where they will be for now. Although much higher than they have been for the last 20 years or so they are what they are. Plans can be made with some assurance.
Consumers on the other hand cannot adjust easily to increase costs via interest rates. Sure, they can spend less on some things, but for the large majority it is what it is. We all need food, shelter and transport. When you increase the cost of borrowing to do some of those things it tends to hurt.
I have been really surprised that so far here in the U.S. we have been able to adjust to these rate increases with not too much trauma. Of course, there is always the recession idea that pundits have been guessing about for the last few years. So far it has not come to that point. Not to say, the risk of recession has not increased, but a recession is not here. The real difficulty in avoiding recession will come down the road when the leveling of government spending, along with higher rates combined affect the economy. Higher rates are starting to squeeze the national budget because debt service is rising with rates. Sooner or later, it must be dealt with.
Right now, business is good despite the rate increases largely because consumer spending is holding up. When you combine that with the trillions the government has injected over the last few years, we here in the U.S. are doing well.
That is not to say we will not have any damage due to the increased rates. Bank loans will come due and a reconning will happen at some point. Office space investing, especially in big city big projects, is a real challenge right now, and all the disruptions in that market are not over with. You can add to that a myriad of other interest rate sensitive businesses must adjust to higher rates and the economic adjustment to all this is not over with by a long shot.
30-year mortgage rates are a prime example of long-term lending. Recently they reached almost 8%, which is a rate not seen here in almost 20 years. New home buyers are not in a good position when affordability due to higher rates makes buying impossible. Home buying and local real estate is frozen. People with low mortgages can’t afford to move and new buyers can’t afford higher mortgage rates. Over time this will even out, but it will be slow.
On the good side inflation seems to be coming down. It is hard to believe when you fill up your gas tank, but the rate of increase in prices is much less than a year ago on almost everything. It is always important to note economic growth does not mean higher inflation. We can increase economic activity without too much inflation. For this to happen the supply must increase to keep up and it looks like that is happening.
I am hoping our economy can weather these storms and avoid a recession.
Where does that leave the stock market? The market will be more volatile because of all the economic adjustments going on. No reason to not be optimistic long term and maybe we will get a bump toward the end of the year.
Thanks, Andy McClung CFP®
2023 Market Results
S&P 500 +11%
NASDAQ Composite +26.5%
Dow Industrials -.01%
Russell 2000 -1.8%
World ACWI +6.8%
Source Wall Street Journal 10/05/23