Endless Summer of Low Interest Rates

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My summer is in full swing.

South swells are rolling through the ocean…

The California sun is shining in all its glory…

The water temps are balmy (at least for the Pacific)…

And there’s enough daylight to put in a full day of work and still surf for hours on end.

Of course, there are still plenty of things that can ruin my best-laid plans.

The wrong tide… onshore winds… simply too many people out in the water.

In today’s market, I think central bank policies are the biggest wild card of them all.

I will be the first to say that members of the Federal Reserve – and most global central bankers – are all very smart people.

At the same time, they are not immune to the same foibles that plague the rest of humankind.

They want to keep their jobs and their power. Some may be overconfident in their own abilities.

Others may actually be scared by the massive responsibility they have.

The list of emotional baggage goes on and on. But the point is that over the last two decades, U.S. central bankers have repeatedly turned toward easier and easier money at every rough patch in the road.

And now they’re discovering that it is nearly impossible to reverse course in any meaningful way.

Current Interest Rates

For a little while, it seemed like they were actually getting us back to some semblance of normal.

In my mind, “normal” is around 5%. I say this because the long-term average Fed Funds rate is 4.8%.

Right now, we’re at a targeted range of 2.25-2.5 and an effective rate of 2.41%.

You’d think half of normal is low, but it’s actually high based on the last two decades.

Take a look…

As you can see, ever since the original tech bubble popped, the Fed has only managed to get its interest rate target back above 2.5% for a relatively brief period before another bubble – this time in real estate – rose up and popped.

Now, after finally tip-toeing back up over the last several years, we’re already hearing talk of a new round of rate cuts.

Based on Fed-funds futures, market participants are essentially certain that we will see a rate cut at the end of this month… and they see a 16% chance it will be for half of a percentage point!

What a massive reversal!

Take a look at the Federal Reserve’s so-called “dot plots,” which show each individual voting members’ forecasts for interest rates going forward.

This first one is from June, 2017…

As you can see, most FOMC members were expecting rates above 2.5% by this year and holding somewhere between 2.75% and 3% beyond.

Now here’s the one from June, 2019…

Notice that seven members of the FOMC now expect rates to go back below 2% this year and to stay there in 2020…

Five see that continuing all the way through 2021…

And 14 of 16 FOMC members now believe rates will be at 3% or lower in 2022 and possibly beyond.

There’s always some new reason why rates need to stay low (or go lower still).

This time around, it’s a nebulous batch of uncertainties.

How Market Uncertainty Affects Rates

As Chairman Jerome Powell told the House Financial Services Committee during his two-day stint on Capitol Hill last week:

“It appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook. Inflation pressures remain muted.”

You might also translate that as, “President Trump wanted lower interest rates and has essentially forced our hand”… or as “we’re doing everything we can to avoid a Japan-style deflationary period… or both… but I digress.

The point is that it feels like the U.S. is in an endless summer of below-normal interest rates.

And things could go lower still.

Heck, in Europe they’ve been employing negative interest rates – a perverse arrangement where it actually costs people to park their money – since 2014.

Just remember that the weather can change quickly – it can get hotter or cooler, and it’s entirely possible for a storm to blow in… one that can’t be stopped by any amount of monetary policy.

For me, all of this simply argues for a renewed focus on income-oriented investments… especially at the value end of the spectrum.

Specifically, I continue to believe that dividend stocks give the best combination of immediate income… continued capital appreciation potential… and the chance for growing yields even if interest rate targets stay low for years to come.

Many of my favorite names have been lagging just as other parts of the markets look fairly overheated.

To a richer life,

— Nilus Mattive
Editor, The Rich Life Roadmap

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