Interest rates are still very low. The Federal Reserve, which controls short-term interest rates in the US, continues to keep these rates at near zero, which it has since December 2008.
What is the future direction of interest rates? Are changes imminent in the near term? What steps should you be taking now?
The future direction of interest rates
The future direction of both short and long-term interest rates is likely to be higher than now. The key question is when will the increases occur.
Short term interest rates have been near zero since 2008. In early 2015, most economists and Wall Street analysts predicted the Federal Reserve would begin raising short term rates by June 2015. Based on Fed minutes released this week from their April 28-29 meeting, and other economic data, it appears that the Fed will not begin to raise interest rates at their next meeting, June 16-17.
Many analysts are now forecasting that short term interest rates will not begin to increase until September, or even later. When the Federal Reserve does begin to increase short term interest rates, it will likely be very gradual. The one year US Treasury bill currently yields 0.19%. We expect it will still be below 1.00% in early 2016.
The Federal Reserve has less control of longer term interest rates and the bond markets cause longer term rates to move more independently of the Fed.
During early March, the 10 year rate was above 2.23%, dropped to almost 1.83% in early April and has been around 2.20% throughout most of May.
We would expect longer term interest rates, such as 10 year US Treasuries, to increase over the next few years. The changes in these rates may be much more volatile and sudden than for short term rates.
During 1996 – 2002, 10 year US Treasuries were generally between 5-7%. From 2002 – 2008, 10 year rates were between 3.5%-5%. Since then, these rates have been between 1.65 – 3.75%. We expect that 10 year interest rates to increase from the 2% range during 2015-2016, but we would not expect these rates to increase to 5% or above for at least a number of years.
What should you be doing now?
- If you are thinking about buying or selling real estate, we would generally recommend to act sooner rather than later. When interest rates do eventually rise, mortgage rates will go up as the 10 year Treasury rate increases.
- If you have not refinanced a mortgage and your rate is higher than 4.5%, you should look into refinancing at these near historically low interest rate levels.
- We generally recommend that you not pre-pay mortgages, as current interest rates are so low. When interest rates rise, having a very low rate mortgage will be to your benefit. We do not recommend adding additional principal to your monthly mortgage payment. For further information, see our prior blog post, click here.
- On the investment side, we recommend owning a diversified portfolio of very safe and conservative bonds (or CDs) for the fixed income part of your portfolio that is appropriate for your specific situation.
- Other than for 401(k) or smaller portfolios, we discourage investing in bond funds. See our prior blog post on this topic, click here. When interest rates rise, bond funds will incur permanent losses (and more than most people realize). We recommend individual bonds, as appropriate.
- We recommend owning bonds or CDs with short-intermediate maturities, meaning 2-10 years, depending on your specific situation.
- We do not recommend owning bonds with very long maturities, such as 15-30 years, in what will likely be a rising rate environment.