(Bloomberg Businessweek) -- Now that everyone is playing the market, today’s high interest rates are a subject of casual conversation, like talking about the weather. And like the weather, they’ve had unpredictable effects.
In a little more than two years, the US Federal Reserve has raised the federal funds rate, the benchmark that influences the cost of borrowing just about everywhere, from near zero to more than 5.25%. That’s a big change on its own, but it also represents an almost generational shift. The last time this rate was above 5% was 2007, the same year the iPhone was introduced. No one under 35 has had to manage their finances with US rates this high in their adult life.
Some of the fallout has been predictable. Carrying a balance on a credit card is more painful nowadays, and would-be homebuyers are finding they have to settle for smaller houses or longer commutes—or renting—as mortgage costs soar. On the other hand, savers are collecting inflation-beating yields now. But there’s also been a puzzling lack of reaction in areas where you’d normally expect a large, negative impact, such as the stock market and housing prices.
To think through what’s behind those anomalies, as well as what higher rates mean for consumers and investors, Bloomberg Businessweek asked financial planners and market experts for their insight and advice.
How Did We Get Here? And How Long Do We Have to Stay?
The federal funds rate is what banks charge one another to lend money overnight, and the costs of other loans are built on top of that. The so-called prime rate, or the base rate for credit card and other consumer loans, is up to 8.5% from 3.25% at the end of 2021. In the same time frame, the average 30-year mortgage rate has risen to around 7% from about 3%. Corporations, meanwhile, are paying about 5.3% to borrow when they issue investment-grade debt, up from 2.3%.
The Fed tweaks borrowing rates to strike a balance between growth and inflation. Starting in 2008 it was mostly in growth mode, keeping rates low to stimulate borrowing and spending in the wake of, first, the financial crisis, then the Covid‑19 pandemic. That changed dramatically in 2022 after the economy reopened and the Fed found itself fighting the fastest spurt of inflation since the early 1980s. Inflation is now back down to 3.3%, in striking distance of the Fed’s long-term 2% target.
This has led many analysts and traders to expect rates to start coming down soon, though Fed Chair Jerome Powell is looking for more evidence that inflation is cooling. Investors can expect at least one rate cut this year, according to Rob Williams, managing director for financial planning, retirement income and wealth management at Charles Schwab Corp.
It’s a Good Time to Borrow Less and Lend More
Thanks in part to pandemic-era government programs that shored up household balance sheets and now historically low levels of unemployment, consumers have been resilient in the face of higher loan rates. But signs of strain are showing. The pace of credit card and auto loans moving into serious delinquency—meaning payments are overdue by 90 days or more—rose in the first three months of 2024, according to a report from the Federal Reserve Bank of New York. Credit card delinquencies are higher than in pre-pandemic days.
One kind of debt worth keeping an eye on is the short-term “buy now, pay later” borrowing offered through retailers and phone apps. These programs proliferated during the near-zero-rate era, offering easy terms as long as they were paid back on time. But costs can shoot up if you miss payments, and some borrowers seem to be struggling to juggle their obligations across multiple BNPL programs. An April survey for Bloomberg News by Harris Poll found that 43% of those owing money to such services said they were behind on payments.
The flip side of this pain is how much more you can get just from stashing money in the bank. Many high-yield savings accounts offered online, as well as many certificates of deposit, pay 4% to 5%, with deposits guaranteed by the Federal Deposit Insurance Corp. Investors with idle money sitting in their brokerage accounts can get an easy bump just by moving money out of low-paying “sweep” accounts and into money-market funds paying more than 5%. Money markets aren’t FDIC-insured, but they generally invest in low-risk, short-term assets.
Those willing to take a little more risk can consider longer-term bonds and bond funds. When interest rates were ultralow, investors were hesitant to put money into assets with such low yields and return potential. “Investors felt like, when choosing between stocks and bonds, they had to invest in stocks,” says Noah Damsky, principal at Marina Wealth Advisors in Los Angeles. “Investors leaned so far from bonds that their portfolios were sometimes entirely stocks.”
In fact, many bond funds took painful losses in recent years, because the market value of existing bonds falls when interest rates rise. But now yields are strong, even after inflation, giving investors a cushion. “It’s much easier to have a balanced portfolio with a substantial amount of fixed income,” Damsky says. “Those nearing retirement can return to balanced portfolios and sleep well knowing that fixed income can deliver real returns while serving as a hedge against troubles in the stock market.”
Stocks Are a Little Weird Now
Hedging might seem counterintuitive, because the S&P 500 continues to reach new highs this year. That’s not in keeping with the typical economic script for higher rates; normally one could expect increased borrowing costs to eat into corporate profits and slow economic growth. And the low-risk returns that investors can make by buying bonds now ought to make them more skeptical of paying high prices for stocks with uncertain gains far in the future.
But investors have a very big vision of the future in their mind—and it’s overriding quotidian concerns about rates. With artificial intelligence promising huge changes in the economy, technology stocks are on a tear. Even after a recent dip in price, semiconductor giant and AI darling Nvidia Corp. is responsible for more than 32% of the S&P 500’s roughly 14% gain for the year as of June 28. The 10 most valuable companies on the S&P 500—most of them tech-related—make up a record 35% of the index.
This tech boom has been driven by impressive earnings but also by that dazzling story about AI. If confidence in that story wobbles, richly valued stocks are likely to as well. It’s difficult to anticipate such turns, and trying to time the market is a notoriously losing strategy for most investors. But the concentration of gains is, if nothing else, a reason to check whether you’re still as diversified as you want to be—in other kinds of stocks and, of course, in bonds. Higher rates on fixed income also make rebalancing a portfolio grown fat on appreciated stocks more palatable. “For an investor wanting to rebalance, sitting on a lot of gains from equities and on tech stocks in particular, there’s no better time than the present to lock in risk-free returns on cash in excess of 5%,” says Greg McBride, chief financial analyst at Bankrate.com.
Housing Is Even Weirder
At today’s average rate, the monthly payment on a new $500,000 home loan is $1,200 higher than on a mortgage taken out in 2021. You might think home prices would get cheaper to adjust to this affordability squeeze, but it hasn’t happened. Homeowners sitting on 3% mortgages don’t want to give up those rates, so they’re reluctant to sell their houses, squeezing supply.
A New York Fed survey earlier this year found renters saying there’s a 60% likelihood they’ll never own a home—the highest reading since the survey started a decade ago. Renting is now cheaper than owning a typical home in all but one of 35 major metro areas in the US, according to data from real estate brokerage Zillow Group Inc. Data for April showed owners paying 35% of income on housing, versus 29% for renters.
There are still benefits to homeownership, the most important of which is protection from future rent increases (though not from property tax increases). And there’s a decent chance you’ll be able to refinance at a lower rate later. But even if higher rates aren’t enough to keep you from buying, it’s wise to be more conservative on how much you spend. Anthony Syracuse, a wealth adviser and founder of Dynamic Financial Planning in Scottsdale, Arizona, tells clients to think about the potential long-term trade-off in their budgets if rates don’t come down a lot. “If rates held, you’d pay as much in interest over 30 years as you did for the home,” he says. And though the price appreciation of the past few years has clients excited about potential returns, he says, “a lot of people don’t consider the 20- to 30‑year holding periods, and all of the maintenance, repair and remodeling expenses that dramatically bring down the annualized return.”
The tight housing market has some buyers looking for hacks to get a lower mortgage payment. One option getting more attention is a rare type of loan that allows a buyer to take over the existing loan of the seller, including its interest rate. But these so-called assumable mortgages can be tricky to arrange. For one thing, you’ll need to be able to pay the seller enough in cash to replace the equity they’ve built up in the home. This may require a second mortgage on top of the one you’d be assuming.
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