Should You Worry About Rising Interest Rates?

Posted on May 17, 2018 at 8:54 AM PDT by

Chances are  you’ve been hearing a lot recently about interest rates: They’re on the rise, and that might be bad.

As with anything economics-related, the answer is never as simple as “good” or “bad.” What matters is how fast markets must deal with change.

The benchmark interest rate has been low — very low — for a long time. After the 2008 housing crash and Great Recession, the U.S. Federal Reserve stepped in to lower rates dramatically.

Then rates stuck there, at virtually zero, for years and years. Only recently has the Fed begun to reverse course.

For bond investors, a rising interest rate means that they can get a higher return on an array of government bonds. That’s good.

But it also means that bonds with long maturity dates could be worth less as newer bonds pay more in comparison. That’s bad.

Rising interest rates also means that companies must pay more to get money, cutting into profits. That’s bad.

It also means that companies are less likely to borrow lots of money just because they want flexibility, or use it to simply buy back their own stock. Generally, that’s good.

For consumers, higher interest rates mean they will pay more to borrow no credit cards and for home and auto loans. That’s bad.

But extremely low rates might be distorting the home value market, since getting a loan is so cheap. And rising home prices were the cause of the last big market meltdown. So, maybe realism is good.

Back to reality

The U.S. economy has functioned perfectly well in the past on higher interest rates than we see today and even higher than we might have by the end of this year.

After all, any increase off zero can seem like a leap, but historically we’re nowhere near having “high” interest rates at all.

In the end, the Fed is manipulating rates to keep the economy growing and job creation sustained, while controlling for overheated valuations in stocks or real estate.

Likewise, the Fed wants to make sure that inflation doesn’t take root too deeply in the economy. If it does, tamping it back down could take years and cause a few painful new recessions along the way.

So interest rates are rising. Glass half-full, or half-empty? So long as the pace is reasonable and markets don’t panic, probably half-full for now.

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