Interest rates continue to remain low

One of the surprises thus far in 2014 is that interest rates have continued to remain near record low levels.  At the end of 2013 longer term rates were starting to rise.  The expectation at that time was that rates would continue a gradual ascent throughout this year.

What has happened instead is that longer-term interest rates have fallen in recent months.  The 10-year treasury is currently yielding just over 2.5 percent, as of the end of last week, down approximately .5 percent since the start of the year.  Meanwhile, shorter-term rates have remained near 0.

There are several reasons to account for the decline in longer-term rates. The economy in 2014 has failed to increase in strength, and at the same time inflation has remained low.  We have also seen interest rates on a global basis fall, as U.S. rates tend to move with the world market.  In addition the likelihood of a Fed rate increase continues to be delayed.

For those who are borrowers, lower interest rates are a favorable development.  The housing market is extremely sensitive to changes in interest rates. At the start of this year mortgage rates had been in an uptrend, which was starting to put a bit of a damper on housing demand.  Recently mortgage rates have started to come back down.

The 30 year fixed rate conforming mortgage is a little more than 4 percent, with the 15-year mortgage nearly a full percentage point lower. The 30-year jumbo mortgage, common in our area, is about 4.5 percent.  While these rates are still higher than they were in early 2013, they are still quite low on a historical basis.

Lower rates also benefit businesses by making it easier for them to be able to expand.  Very few companies can access credit at rates comparable to what the federal government pays.  However, rates are near record lows for high yield bonds, which is a source of financing for many corporations.

Clearly low interest rates are favorable for the borrower.  For the saver it is a different story.  With short-term interest rates near 0 returns on savings accounts and CD’s are still not even matching the relatively low rate of inflation.

Many savers have ventured into the bond market in search of higher yields.  2014 has been favorable for the bond investor thus far, as investors have been able to earn their interest plus realize some capital appreciation from the fall in interest rates.  For a new investor in bonds current yields are not very attractive, plus there is the risk of loss in market value should rates rise again.

On balance the fall in interest rates should be a positive development for the economy. Housing and auto sales are two key areas of the economy that benefit from lower interest rates.  While economic readings were disappointing for the first quarter of the year, recent data is pointing to an acceleration in activity.

Lower rates are generally a positive for the stock market.  Businesses benefit from a lower cost of financing, and competing investments, such as bonds, are less attractive when rates are lower.

Investors will need to focus on the future direction of interest rates.  It would appear that interest rates are not likely to fall much further from current levels, and ultimately rates are likely to rise again.  This statement is made with the caveat that trying to predict short term movements, whether it be stock or bond prices, is very difficult.

For those who are invested in the bond market, I would recommend keeping maturities relatively short, even though that means sacrificing some current yield.  There should be an opportunity in the future to purchase longer-term bonds when yields will be higher.