Opinion: High interest rates pressure global markets

Twelve months ago, economic forecasters were calling for a recession due to the rapid and dramatic increase in interest rates. Yet, the consumer remains strong. National unemployment is holding steady at a 3.8% rate as of the August reading, and inflation in July trended down to 3.2% from the 9.1% high in June 2022, according to U.S. Bureau of Labor Statistics data. The August inflation report will be released Sept. 13.

Should Americans simply get used to these higher rates, or is there some reprieve on the horizon?

In 2022, global financial markets experienced significant declines resulting from rising rates brought about by high inflation. The Federal Reserve raised the short-term federal funds rate 11 times since March 2022 to combat inflation levels not seen in 40 years. The target range for the federal funds rate sits at 5.25%-5.50% as of August.

From 2004-06, the Feds raised the federal funds rate 17 times, finally landing on 5.25% in June 2006, the level we see today. Two years later, a global recession ensued and drove down asset prices worldwide.

In this cycle, the economy has seemed to digest these higher rates a lot easier than most economists had expected. The real estate market continues to show resilience, even with 7% mortgage interest rates. And even though rates are higher, property valuations remain elevated because of a lack of inventory. People are finding it more attractive to rent or hold on to their 3% mortgage rates and high property values instead of trading up for a 7% mortgage rate.

When mortgage rates were 3% in 2021, the monthly payment on a 30-year mortgage for a $300,000 house was just under $1,300 per month. At today’s rates, the same monthly payment of $1,300 would buy a house worth only $185,000.

We’re in a much different rate environment than we were just a few years ago. In 2019, some overseas bonds traded at negative rates, which means that investors were willing to pay more for a bond than they could expect to receive in interest. In fact, a Danish bank offered a mortgage rate of negative 0.50%, effectively paying customers to take out loans. This turned out to be a better deal for the bank when the alternative was to pay 0.75% to the central bank to keep money on reserve. That same year, Germany issued the world’s first 30-year bond with a 0% interest rate. The U.S. contemplated issuing a 50-year bond to lock in lower yields, but ultimately abandoned the idea because of the prospects for low demand.

Higher rates also put pressure on governments to meet debt payment obligations. Today, the U.S. national debt is over $32.8 trillion, according to the Treasury Department. The longer that rates remain elevated, the larger the share of gross domestic product that will be required to service the national debt.

Bond investors would also embrace lower rates. Bonds typically hold up well when stocks decline. However, with rates escalating as quickly as they did in 2022, bond portfolios were down 13% as measured by the Barclays Aggregate Bond Index. In 2023, bond prices have remained under pressure as rates have continued to rise.

Banks, consumers, rate-sensitive industries and investors with bond portfolios, among others, would welcome lower rates. The Fed is concerned that lowering rates too soon could spark additional spending and cause inflation to tick back up given the strength of this economy. Chairman Jerome Powell said in his speech at the Fed’s Aug. 25 economic policy symposium in Jackson Hole, Wyoming, that “two months of good data are only the beginning of what it will take to build confidence that inflation is moving down sustainably toward our goal.”

At the end of August, the market was pricing in the possibility of one more 0.25% rate increase this year, yet it is expecting rate cuts next year with a high probability that the federal funds rate will be between 3.75% and 5% by the end of 2024. Note that these expectations change very frequently. Fed officials say they will remain data dependent and so, too, will the true cost of managing inflation.

Andy Drennen is a certified financial planner and senior portfolio manager at Simmons Private Wealth in Springfield. He can be reached at andy.drennen@simmonsbank.com.