Interest Rates: Up, Up and Away!?!

In what is widely referred to as the Trump Bump, U.S. stocks have been moving up since the surprise U.S. Presidential election victory of Donald Trump. Stocks have been advancing on the hopes that some of the President-elect’s policies may make it into law. Most notably, lower corporate taxes, reduced industry regulation and infrastructure spending are all viewed as beneficial to corporations and, therefore, their share prices.

What also got a bump during the post-election rally, were interest rates. There are a few reasons interest rates have been rising, but a lot of it has to do with President-elect Trump’s policies. With the prospects of fiscal stimulus and lower taxes, investors are now starting to believe that inflation may start to rise at a faster pace. Ever since the Great Recession in 2008 and 2009, inflation and overall economic growth has been fairly tame. If President-elect Trump is successful in implementing some or all of his economic policies, investors are now worried that we’ll have larger deficits, faster economic growth and inflation will start to rise. And, higher inflation means higher interest rates.

Let’s look at how some interest rates reacted. On the day of the election, the 10-year U.S. Treasury bond offered an interest rate of 1.88%. By the end of election week it rose to 2.15%. As of December 2, it was at 2.40%. In less than a month, the interest rate on the 10-year U.S. Treasury bond increased 0.52%. Mortgage rates for a 30-year fixed rate loan, which are partly based on level of the 10-Year U.S. Treasury bond, increased from 3.54% (November 3) to 4.08% (December 1). Higher rates means it is going to cost more for investors (and the government) to borrow money.

Long term rates, like the 10-year U.S. Treasury bond, are not the only ones going up. Since unemployment is low and the economy is accelerating, investors generally believe that the Federal Reserve will increase short-term interest rates when they meet in mid-December. According to the CMC FedWatch tool that estimates the probability of a rate increase based on investor trading, the current odds of a December increase are almost 95%. If there was a sure thing in investments, this seems to be it.

There are good and bad aspects to rising interest rates. On the good side, rising interest rates mean that investors should generally expect to earn more interest from their bonds and savings accounts. This is welcome news to savers as their cash flow should improve. However, rising interest rates typically sends bond prices lower, and, the longer the maturity of the bond, the greater the price reduction. So, while savers may get more interest from their bonds, the value of those bonds could be lower.

Additionally, higher interest rates translate into higher borrowing costs for individuals and corporations. Fortunately, even after the post-election interest rate increase, rates are still fairly low versus history. Therefore, borrowing costs remain quite reasonable and are supportive of continued economic growth.

While time will tell if the trend of higher interest rates is here to stay, we continue to believe that bonds are an important part of an investor’s portfolio. The type of bond investors hold truly matters in this investment environment. For our clients, that means they will see the use of short-term bonds as a prudent way of managing against interest rate changes now and into the future.