A picture is worth a thousand words! So, just what are we looking at? This is a chart showing the yield on the 10 year US Treasury Note back to 1962. We’re going to refer to the yield as the interest rate for the purposes of this article. Some of us are into charts. Others, understandably, are not. In short: interest rates are as low as they have ever been. Ever. 1
Why is this important? The rate on the 10 Year affects anyone who wants to borrow money, ranging from corporations to all of us on proverbial Main Street. It is a key rate that helps determine borrowing rates for everything from car loans to mortgages to corporate bond issuance.
Many of us have become homeowners in a time when 5% seems like a normal mortgage rate. That is even considered high right now for those with stellar credit. Given that figures on the chart range up to nearly 16% and mortgages include a “spread” above the 10 Year rate – that’s pretty amazing. Many may remember mortgage rates in the early 1980s when a prime borrower was rewarded with a whopping 18% rate, plus points. Note that Everest-like peak in the chart from 1980 to 1986. Even as we consider the possibility that rates will head north, we are still in a historic, phenomenally low interest rate environment.
Many believe these low interest rates helped to drive real estate values. Real estate prices are supposed to move up and down – perhaps in response to movements in interest rates and in conjunction with other economic factors. Borrowing rates fluctuate too but, going back to the chart again, we are likely in the midst of multi-generational lows in interest rates. Our grandchildren may not even see rates this low in their time. It is extraordinary.
The trends around this could be debated for eons by market participants and academics but what do we do? What’s the prudent thing to do for those of us just trying to make good financial decisions in this environment? We hold long term, fixed rate debt.
By no means are we suggesting over-extending. We’ve all seen what happens when the world goes debt crazy, a la 2008. (Again, insert endless academic debate about cause and effect, prolonged low rates, etc.) That said, if you’re questioning whether to finance something, particularly a big purchase: taking down long term debt at fixed rates makes more sense now, based solely on rates, than it ever has.
This is also why we’ve seen record levels of corporate debt issuance this year.2 Corporations know it’s prudent to borrow money now and lock in their costs at these extraordinarily low rates. The list of issuers just this year is huge: the legendary Berkshire Hathaway took down $2B, Microsoft took down nearly $20B to finance the purchase of LinkedIn, Apple has borrowed over $15B and they have a notoriously large cash stock pile already.
One might wonder, given all the benefits to borrowers, why shouldn’t the Fed just leave rates low forever? For those of us who are investors and/or savers, we see that downside in real dollars on the other side of our personal balance sheets. Low yields on bonds and CDs. Zero percent on savings accounts. It’s often a nominal 1 basis point which is .01% or: virtually nothing. There was a time, way back in misty memory, when money markets paid 6%. So, while this rate environment is a major boon to borrowers, it effectively punishes savers. One might wonder, after 2008, if that’s the approach that should be in place but that’s neither here nor there. (It’s not an accident. The strategy is called Financial Repression. Another one for the academics.)
The longer term health of the economy is also potentially an issue with unusually low interest rates. If we think about the tools the Federal Reserve has at their disposal to help guide unemployment and inflation, the ability to control short term interest rates is definitely the largest and most easily wielded. (The Fed directly controls the Federal Funds Rate which is the overnight rate at which banks loan to one another. They do not directly control Treasury rates.) If we stay near zero on Fed Funds and the economy turns south, there’s little room to lower rates to protect us from a protracted downturn. (Negative interest rates, which are prevailing in Japan and Europe, are a whole other topic for another day…)
We hope this shines a little light on the longer term trends in interest rates and borrowing. If you have questions about your own balance sheet, feel free to reach out.
Alisa Chatham Sakowitz has been a Financial Advisor for over 17 years. She has an undergraduate degree in Creative Writing from the University of Arizona and an MBA from UC Berkeley’s Haas School of Business. After a long career with Morgan Stanley, Alisa joined her family in their advisory practice at Park Avenue Securities. She lives in Sacramento with her husband who is a photographer, their two young sons and a Great Pyrenees named Sprocket. Their lives are happily full of work and play.
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1 WSJ, July 5th, 2016, 10 year closes below 1.4%. Lowest close on record.
2 Bloomberg Global Corporate Bond Deals, Issuance 1st week of August