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Low Interest Rates

Apr 02, 2019Tyrone Wiseman

What Happens When Super Low Interest Rates Rise?

Whether it's your bank slugging you 19% interest on your credit card in 2017, or traders in Mesopotamia charging 20% in 3,000 BCE, interest rates have a long-held and important role to play in the financial system.

If you're a saver looking to earn interest, the higher rate the better.

If you're a spender with debt, then lower will serve you well.

And like a rollercoaster, they go up and down.

Chart 1

Source: Business Insider

Interest rates are currently at their lowest level in 5,000 years, hovering around the 1% - 1.25% mark. 

And you (or your parents) might also remember when mortgage interest rates were at 17% here in Australia. That's pretty different from rates today, thank goodness.

Chart 2

Source: Loan Sense

You might think the US have the lowest rates around, but in some parts of the globe, rates are so low, banks pay you interest on your home loan. They're called negative interest rates, and they were happening in Denmark in 2016 (who interestingly, also offer 1,000 year bonds).

Now there's a policy that encourages people to go into debt!

You see, central bankers from around the world, like those at the Reserve Bank in Australia of the Federal Reserve (the Fed) in the US, use interest rates to try to manipulate, stimulate and manage economies. In simple terms, low (or negative) interest rates encourage spending, and high interest rates cause people to pull back.

Particularly since the GFC, bankers have been trying to stimulate economies by reducing and keeping interest rates low. And one of the impacts of this, is there's now a bull market in just about everything. 

"More significant still is the behaviour of long-term interest rates. 
They have fallen steadily since the 1980s and remain close to historic lows. 
And that underpins all sorts of other asset prices. A widespread concern is that 
the Fed and its peers have grossly distorted bond markets and, by extension, 
the price of all assets." - The Economist.

We don't have to look too far to see the impact. Share portfolios have increased in value, and property prices have seen a rapid rise. We can't completely blame the Chinese buyers and SMSF investors for the property boom along the east coast - it's the low interest rates that have helped. 

In recent times it does appear that property price growth is slowing in Australia, and it might be just as well. Around the world, wage growth hasn't kept pace with inflation, which has left people with less money to spend on the rising cost of living. 

But at some point, interest rates will increase to more normal levels. It will become more expensive to borrow money (think pricier mortgages), which in theory, will likely lead to a decline in consumer spending. Increasing rates can also lead to a decline in business growth because loans are harder to secure. That can lead to lower company profits, lay-offs and the stock market taking a hit.

“While it might scare the pants off mortgage holders, interest rate 
rises should be viewed as a good thing. They would signal that the 
economy is finally picking itself off the floor,  that the reserve genuinely 
believes some pay rises are coming and that job prospects 
are really improving.” - Sydney Morning Herald.

You'll remember that the world has the lowest interest rates across civilisation in 5,000 years. That means there's no "here's what we did last time" guide book on how to bring rates back up to more normal levels. The Fed have some targets for how they might do it, and Australia hasn't started to raise rates yet. 

Truth it, it's all a bit of an unknown.

What is clear, is that no one can accurately and confidently predict the impact of raising rates on the value of assets like shares and property. It's all economic theory. 

So in lieu of a crystal ball, we're making sure our clients have portfolios flexible enough to weather the rough seas that may be ahead.