International events drive interest rates lower

One expectation that I had for this year was that international events would have a significant impact on our markets. As we start this year, this certainly is the case especially as it pertains to interest rates.

Unlike the stock market, which only affects people who have money to invest, interest rates impact both savers and borrowers. A change in interest rates can frequently have a significant affect on one’s financial circumstances.

What has been occurring over the years is that the world is becoming more interconnected.  What this means is that investors are frequently looking to overseas markets to place their money. Foreign investors are often meeting the demand for U.S. government debt.

While interest rates are near record low levels in the U.S., for example the 10 year Treasury ended last week at just over 1.8 percent, they are even lower overseas. In Japan its 10-year government debt yields .2 percent, .4 percent in Germany, and just more than 1.5 percent in Spain and Britain.

For a U.S. investor getting less than 2 percent a year for a long-term investment does not appear very attractive.  However, for the foreign investor U.S. yields look considerably better, especially when the dollar is gaining in strength.

What has been occurring is that central bankers overseas have been trying to stimulate their very weak economies. This has allowed interest rates to go to exceedingly low levels. While our economy has been gaining some strength, which would normally imply higher rates, weak overseas events are causing global rates to stay low.

Just last week the Swiss removed their peg to the Euro, which caused their currency to appreciate significantly. This caused turmoil in the financial markets, and drove interest rates even lower throughout the world.

The most noticeable affect of lower interest rates is on the mortgage market. Mortgage rates move in the direction of changes in the 10-year Treasury yield. Currently 30-year mortgage rates are approaching 3.5 percent, which is very close to an all time low.

This drop in mortgage rates is allowing a new wave of refinancing to occur.  In addition the lower mortgage rates should help housing affordability.  This is a major issue in our local area, given the high cost of housing.

The more difficult question is where interest rates go from here. For the near term longer-term interest rates will probably stay quite low in the U.S. This is based on the likelihood that interest rates will stay at very low levels overseas.  It will take time for the economies in Europe and Japan to recover.

This does not necessarily imply that interest rates stay exactly where they are now, but will probably not rise significantly in the next few months. However, looking longer term it is not realistic to expect interest rates to stay at these exceedingly low levels.

So far 2015 has started off in a relatively volatile manner due to continued turbulence overseas.  Given the high volatility, investors, especially foreign ones, tend to gravitate towards the safety of U.S. Treasuries. For the time being would expect this volatility to remain elevated, though eventually it should abate.

With interest rates near record low levels I would not recommend investors purchase longer-term bonds. Eventually yields will be higher, and there will be better opportunities to buy bonds.  However, if someone is a borrower, now is a good time to obtain or refinance a mortgage.