Interest rates affect everyone, whether you're a borrower or a saver. For borrowers rising rates mean higher carrying costs on debt, for savers it means higher income on vehicles like savings accounts and GICs.
But in terms of the stock markets there is quite often a disconnect, with retail investors bullish when rates go down and bearish when they rise. There is some logic to that thinking, because when rates go up so do things like the cost of buying on margin. And when rates go down, those using leverage to purchase stocks see those costs drop.
But rising rates should be cause for bullish excitement, while falling rates should spark concern.
Quite simply central banks raise rates when the longer term outlook for the economy as a whole is good, and they lower rates when there are fears of recession, or when a recession as already taken hold. What good are cheap borrowing costs when there are less people working and less money circulating in the economy? Conversely, who cares if the cost of borrowing is more expensive if that means there will be more money circulating as employment levels rise along with those working getting increased wages.
For younger readers though, those who have come of age in the last 10 years or so, rising interest rates might come as something of a shock. This was only the second rate increase in the past year, and it signals that we're coming out of the emergency low interest rate environment that was spawned by the Great Financial Crisis (GFC) in 2007/2008.
There are a generation of borrowers who think a fixed mortgage rate of under 3% is normal. When I sat down with my bank a couple years back to negotiate a mortgage I had a different term, "stupid cheap". My wife was thinking of shaving a few tenths off by going variable, and maybe buying the rate down some. But at well below 3% I was more than happy, being able to remember rates much higher, like 5, 6 and 7.....there were even crazier rates back in the early 90s, but I wasn't taking out mortgages back then.
Rising rates will cause some problems, there are some people who are addicted to cheap debt, and they're going to be in for some severe pain if the US Federal Reserve sticks to its guidance of another 3 rate increases next year.
But for the overall economy in general, and stock markets in particular, this is a very good thing.
Hey Joe,
ReplyDeleteHope you're having a good new years. Actually, I'm not really worried about interest rates, I am actually worried that the current low unemployment rate, the length of the economic boom, the rising US corporate delinquencies (according to FRED), the size of the Chinese housing and debt bubble, waning US industrial production figures (FRED) all suggest to me one of two things:
- we are nearing the top of the aggregate supply / aggregate demand curve, and we area headed for a period of sustained higher interest rates
- we are nearing another recession
I made my first rates with TD waterhouse mutual funds, and one of my first stock trades was hemosol in the early 2000s. I also worked as a bank teller in 1998, for Toronto Dominion Bank before and during the acquisition of Canada Trust.