Quarterly Newsletter 09/30/2023
I HATE HIGH INTEREST RATES!
Ok I said it. I don’t hate many things, but there is one thing I definitely hate and its high interest. I have a feeling after reading this letter, you will hate them too, so let’s get started.
The first reason why I hate high interest rates is increased borrowing costs. As you all know, higher rates make borrowing more expensive. All you have to do is look at mortgage rates. Last year the 30-year fixed mortgage rate hovered around 3.5%. Currently it hovers around 7.5%. This makes the monthly payment on a mortgage much more expensive. Companies are also affected by increased borrowing costs as a result of higher interest rates. If a company has to pay more of their revenue towards interest, there will be less for investment, growth, and expansion. Governments also have this issue. The more money paid towards interest, the less there is for public services, military defense, social programs, etc.
The next reason why I hate high interest rates is the potential for reduced consumer spending. Higher interest rates on loans, mortgages and credit cards discourage consumers from spending. This can lead to a decrease in demand for goods and services which ultimately impact businesses and the overall economy.
Higher interest rates also affect the housing market. Higher rates mean higher monthly mortgage payments. Higher monthly payments mean home affordability is less. If homes are not affordable and people are priced out of them, there will be less turnover. Less turnover means less economic activity. Think about all of the professions affected by a house sale: appraisers, inspectors, contractors, real estate agents, title companies, notaries, government employees and more. A slowdown in home turnover is not good for the economy. Also, when interest rates rise, home values tend to drop. When home values drop, homeowners overall net worth drops and psychologically people tend to spend less when they feel less wealthy.
The next reason why I hate high interest rates is the potential for business investment decline. Businesses often rely on debt to finance expansion and capital projects. When interest rates are higher, project costs increase, and this could lead to a reduction in business innovation, expansion, and productivity.
Exchange Rate Pressures: High interest rates attract foreign investors who seek better returns on their money. When a foreign investor looks to buy a dollar dominated investment (such as a treasury bill or stock) they first have to convert their local currency into dollars. This can lead to an appreciation of the dollar. While an appreciation of the dollar would be good for Americans purchasing international goods and services, it could negatively impact export competitiveness for US based companies, potentially leading to trade imbalances and loss of revenue for international companies.
Higher interest rates also lead to debt servicing challenges. Governments, businesses, and individuals that rely on debt to finance their purchases may run into issues servicing that debt if interest rates are rising. As discussed before, higher rates mean higher monthly payments, and this can put a strain on a government, business, or individuals cash flow. When more money goes towards paying interest, a government either needs to raise taxes or borrow more to pay for the shortfall. Same thing with companies. Higher interest expense requires companies to either increase revenues or take on more debt to afford the higher payments. Individuals run into the same problem as well. Increased monthly payments require individuals to find ways to cut expenses or increase wages. If you get to the point where the debt payments become too burdensome, bankruptcy becomes the only option.
The last, and in my opinion most important reason why I hate high interest rates is the effect on the stock market. Higher interest rates negatively affect the value of stocks when using a discounted future cash flow valuation model. They also make bonds and other interest-bearing investments more competitive with stocks. The ultimate question is why I would buy a stock that has potential for loss when I can buy a treasury bill, note, or bond and receive a guaranteed rate of return from the government? A shift to interest bearing investments may lead to a decline in stock values and negatively affect the wealth of equity investors. When people feel less wealthy, also called the negative wealth effect, they tend to spend less. Spending less typically results in an overall slowdown of the economy since consumer spending makes up a large percentage of our gross domestic product. And ultimately this is not good.
All in all, higher interest rates are not good. They are not good for the government, they are not good for businesses, and they are not good for the general public nor the economy. They are not good for the stock market, and they are not good for the bond market. It’s pretty hard to find anything higher interest rates are good for. So, hopefully I have convinced you to hate high interest rates like I do.
As always, we thank you for your continued partnership. If you’d like to chat with us about your specific financial plan, please give the office a call and set up an appointment.
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