Interest Rates Are Finally Spiking – What it Means

After years of (artificially) depressed interest rates on everything from US Treasuries to savings vehicles like money markets and CDs to borrowing rates for consumers, we finally saw a spike in interest rates in May.  If rates keep rising at a similar rate in the coming months, there will be broad ripple effects in the economy and to most routine Americans.  Here are the implications for a series of financial interests:

  • Mortgage/Refi Rates – We’re already seeing mortgage and refi rates spike upwards since they tend to track the yield on the 10-Year Treasury pretty closely.  The 10-Year is now at about 2.1% from a low of below 1.5% earlier in 2012.  That’s a significant move, so we may well have seen the best mortgage and refi rates of a lifetime.  If you are in position to do so, I’d do it now!  I usually think there’s more time, but at the moment, there are no tools left in the Fed’s arsenal, so the only thing to drive rates down again would be another severe recession, which might take a couple years to come to fruition again.
  • Other Borrowing Rates (Auto Loans, HELOC, etc.)  – As with housing borrowing rates, we should expect to see all lending rates increase.  Similarly, if you were planning on taking out an auto loan, you’ll probably get a better rate now than later. Also, if thinking about tapping equity in your home, now’s probably a good time.  I already just locked in a 3% rate to tap some of our equity to do windows rather than using cash out of pocket, since this is effectively a 2.something % loan, which is below inflation.  The way I look at it, I’m borrowing for free when considering inflation.
  • Savings Accounts, CDs, Money Markets – We may finally see savers rewarding with rising rates on safer investment vehicles.  I think this will take months, if not 1-2 years to play out to the point where you’re finally getting a reasonable yield over inflation, but things should start moving in the right direction.
  • The Risk Trade Over? A primary reason equities have rallied (aside from strong earnings on cost-cutting), is that investors have been pushed into the risk trade with such low rates everywhere else.  As we see this trend reverse, will funds flow back out of equities into safer instruments?  It’s quite possible.
  • Dividend Stocks Out of Favor? A strong driver for owning dividend stocks of late has been the potential to earn a capital gain plus dividends paying more than any safer investment yields, bonds included.  When CDs are paying 1% and you can earn 4% in a blue-chip stock, the case if pretty compelling.  Well, once CD rates pop back to 3-4% for longer dated maturities, the case for owning dividend stocks becomes less compelling.

In general, the Fed’s intervention to depress interest rates here and around the globe have certainly been a positive for investors, the economy and Americans at large.  But obviously when the Fed Funds rate is dropped to its absolute minimum, there is nowhere to go but up.  So, ultimately, we must now face the reckoning which will be a headwind in all facets of the economy from borrowing costs, the flows out of equities to lack of consumer spending, decreased hiring, etc.  We knew it would come eventually, it’s just been a question of how long.  Given the current stock market euphoria, investors must be thinking that this will play out over a long enough period of time that it’s manageable.  Hopefully that’s the case.

About Everyday Finance 67 Articles

The author has a background in Chemical Engineering and an MBA specializing in Finance and Biotech Management. Enamored by investing and saving since a teen, the author has been an advocate for optimized investment returns and strategies.

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