Owatonna, MN Correspondent– The U.S. economy has been chugging along at a slow-to-moderate pace since the current recovery began back in 2009 after the Great Recession ended. Part of the reason for that steady growth and lack of volatility in the stock market must be chalked up to historically low interest rates. Rising interest rates may precipitate a recession, but that’s not a certainty.
Stocks and bonds are the two largest liquid asset classes in the world. They naturally compete for investor dollars. If interest rates rise, investors are more likely to purchase bonds since they are a safer investment than stocks. When interest rates are low, stocks become more attractive for their potential for greater returns despite the riskier nature of equity investments.
The Federal Reserve (Fed) directly controls short-term interest rates. These rates influence long-term yields on investment such as mortgages and Certificates of Deposits (CDs) because investors expect higher interest rates to counter the risk of locking up their money for a longer time. If interest rates rise substantially, there could be a mass exodus from stocks to bonds as investors, particularly those who are retired or on a fixed income, flock to higher-yielding bonds. These investors have had to suffer through the past seven years of abnormally low interest rates and have either fallen behind with their purchasing power or have had to accept more risk to get high enough dividends from stock investments to augment their reduced bond interest.
If the Fed maintains their stated goal of gradually raising rates as the economy will bear, it’s likely that the economy will continue to grow slowly and recession will be avoided in 2017 or 2018. However, if our economy overheats because of a tightening job market, rising wages, and the resultant inflation, interest rates may shoot high enough to cause a mass exodus from stocks to bonds, which would cause a bear market in stocks and negatively affect the world economy.
Other factors that may impact the U.S. economy include war, financial crises in large economies such as China, India, and Russia, or large-scale terrorist attacks that disrupt the global economy. The Fed has no control over these possibilities. Also, they have a history of managing the monetary supply in hindsight, like a driver who is only able to steer a car by looking in the rearview mirror. In other words, the Fed tends to be slow to react since it can’t accurately look ahead. If too many world crises crop up ahead of us, the Fed’s rearview-mirror vision of the economy will fail once again, and we’ll see a steep recession which will correct the overvaluation currently seen in the stock market.
Prescott Valley, AZ Correspondent– Rising interest rates will have an impact on everyday Americans, but it will depend on how the rate hikes affect the financial affairs of everyday citizens coupled with the economic repercussions that Americans will have to deal with because of the interest rate hikes.
Everyday consumers will probably see increased housing costs, higher interest on credit cards, vehicle rates, student loans and other unforeseeable expenses that are directly and indirectly affected over the course of time. When the Fed raises rates, overall cost increases in various areas might not be immediately apparent, but the cumulative effect will eventually be felt as each of these consumer driven areas of the economy will be subject to the increases.
Rising interest rates should not cause a recession in the next year or two, but it will depend on how the Federal Reserve’s hikes affect those Americans who have lost so much through a declining economy over the last eight years. They are the individuals who will suffer the most with increased interest rates and if the economy is not infused with viable and sufficient jobs and improved salary levels over the next year or two, recession could be a possibility.
Those Americans who have managed to maintain savings accounts will most likely earn a little more interest on their savings through the rate hike, but that will hinge on how often the Federal Reserve raises the rates. Differences probably would not be felt for several years, even with a number of rate increases over several years’ time. Any gains by savings account holders would be small at best, yet would bring some relief and hope to account holders.
Mortgage rates are another factor that homeowners and potential homeowners will have to take into account, but the length of time of most mortgages (30-year, fixed-rate) is somewhat protected because the Fed rate does not have a critical effect on long-term mortgage rates, though banks do and will find ways to pass on higher borrowing costs on to consumers. If interest rates on mortgages do rise even by one percent, potential homeowners will see an increase in mortgage payments and may not be able to afford a home, which will also depend on whether there are job and salary increases to compensate for rising housing costs. As mortgage rates increase, there will likely be fewer people buying houses and those on fixed-rate mortgages will probably not refinance.
With credit card interest rates already being high (15 to 20 percent), Fed increases could affect those rates by one or two percentage points, which with compound interest could take accumulated credit card debt to unmanageable levels for some credit card holders. With so many people living off credit cards these days, any rate increases will push overall credit card debt higher and make repayment a worse situation.
Student loans will come under fire as well. Though interest rates on student loans are currently low, students taking out loans in the future will see higher payments at higher percentage rates. Again, unless job and career options don’t improve, student loan recipients will be looking at paying back loans with little in quality job returns.
Car loan rates are already climbing in expectation of the Fed’s increases, but buyers looking to purchase cars in 2017 should be able to get ahead of the game as the Fed has indicated that interest rates will continue to rise over the next ten years. So, buying a vehicle now at a lower rate would probably be advisable rather than waiting on rates to increase. A vehicle financed in 2017 could escape increased interest rates, plus be paid for by the time another rate increase was implemented.
Those who don’t have homes and have to rent may be affected in an indirect way by increased interest rates. Property owners and landlords could pass on their increased costs of property maintenance to their renters through increased rents, but with labor market improvement and increased wages for workers, rent hikes could be more easily handled by renters.
Rising interest rates will not likely cause a recession in the next year or two, but that assumption is based on the economy progressively getting stronger as well as people currently unemployed, underemployed, and employed part-time (or just entering the job force) are steadily employed and paid well.
Though it does appear that there are jobs currently opening up and being created, it remains to be seen whether that trend will be a strong enough surge to offset the increase in interest rates. No one likes higher interest rates, but if it means stable employment and a moving economy as opposed to a recession, Americans will have to bite the bullet like they always do and take the increases for the sake of a better life.