Lower Interest Rates – The Good And The Bad

Lower Interest Rates – the good and the bad

First the good news.

The Federal Reserve lowered interest rates by 0.5% earlier this week in an attempt to help support the economy as fears about the potential economic impact of the Coronavirus spreads.  The U.S. 10-year treasury is now below 1% for the first time in history.  As interest rates go down, the value of bonds moves up.  For bond investors this move lower in interest rates has been a good thing as the rise in bond values has helped to offset the decline in stock prices. 

Debt financing.  Lower interest rates may provide an opportunity for homeowners who have a mortgage to refinance their mortgage at lower rates.  Feel welcome to reach out to us if you would like help finding a mortgage broker and if you would like us to review the fees associated with refinancing.  Before refinancing your mortgage, it is important to compare the potential interest savings versus the refinancing fees and the new mortgage terms. The new mortgage terms should align with your cash flow and other financial objectives.  One piece of advice is if you are refinancing a mortgage, do not extend the time you have remaining on that mortgage.  If your originally took out a 30-year mortgage and there is 15 years left on it, do not refinance back to a 30-year mortgage, as the savings to your monthly cash flow (due to lower mortgage payments) will be offset by paying more interest over time.

Now the bad news.

Bonds have increased in value as interest rates have moved down.  At some point, interest rates will rise, and bonds will lose value.  The amount of loss will depend on a host of factors, including the duration of the bonds and credit quality.  In order to reduce future interest rate risk investors may have to reduce their bond exposure and increase their allocation to cash or alternative investments, neither of which provides as much downside protection against stock market volatility.

Future returns on bonds will be much lower than they have been over the past 30 years and this will have an impact on overall portfolio returns.  Going forward, it will be more difficult to achieve historical returns from a balanced portfolio.  This means investors must take more risk or accept lower returns.  As a firm this dynamic of low interest rates and lower future bond returns is front and center when reviewing portfolios and projecting returns into the future.

A key question is when will interest rates start to rise?  Most economists believe the Coronavirus will slow global economic growth for the first and maybe second quarter of the year at which point they look for a bounce back in growth as the virus becomes less prevalent with warmer weather and vaccines are created.  The stock and bond markets are always anticipating the future, which makes timing the markets impossible.  For our clients, we will continue to make sure their portfolios are aligned with their long-term goals and risk tolerance.