Why Are Interest Rates Trending?

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Oct 15, 2019 3:19:49 PM

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interest ratesBrexit. The impeachment. Hong Kong. The trade war. That’s a lot to discuss and to worry about. As always, though, there is a difference between what makes the headlines and what really matters. Not that those issues don’t matter—of course, they do. But in a couple of weeks or months, we will be talking and worrying about something completely different. Headlines come and go, but the deeper issues show their effects over years.

Taking a deep dive on interest rates

What I try to do in my talks at Commonwealth’s National Conference is to identify what the deeper issues are likely to be. These topics are the ones we will be talking about in the next year or more to come, and then I do a deep dive on them. Last year, for example, I talked about the growing disconnection between China and the U.S., plus what that could mean not only for trade but also for geopolitics. This discussion included the prospect that the global economy could end up being restructured around politics, rather than economic optimization. On the whole, it was a pretty good call, as that is exactly what we are talking about now.

This year, I chose to talk about interest rates. When I started putting that presentation together a couple of months ago, I was seeing more media coverage of the issue and had started getting more questions. Now, the topic is starting to trend even more. So, what we will do here over the next several posts is take a deep dive on where interest rates come from, what they mean for the economy, and, most important, what they mean for us as citizens and investors.

Why should we care?

The first question we have to deal with, though, is why we care. Interest rates have been a perennial topic forever, and it is not obvious why we should care more now than we ever have. The reason is this: although interest rates have been dropping for decades, recently, there have been more and more reasons to expect them to start rising again. Indeed, they had started to do so, and with the Fed hiking its rates and with growth continuing, the expectation was that rates would move back to “normal.” (In a bit, I will explain why I put “normal” in quotation marks.) And there was much rejoicing.

Instead, however, rates dropped sharply over the past six months, against all expectations, leaving them even farther from normal than before. Clearly, something was wrong. Was growth going to crater? Was the economy about to collapse? Well, no. Interest rates were just not acting like everyone expected them to. Interest rates were not acting normal, even when economic conditions had normalized. Something is clearly broken, either in the economy itself or in the way we understand it.

What is the new normal?

Interest rates will continue to trend because of the disconnect between what we understand normal to be and what it actually is. Further, we need to evaluate what is really going on here. Has normal changed? And, if so, to what? What is the new normal? Interest rates are the foundation of the financial markets, so they really are important. And, if we understand where we came from—and why—that gives us a much better chance of understanding where we are going.

Stay tuned!

Tomorrow, we will be looking at where we came from on interest rates, which will lead us to trying to understand the why and, finally, to what that all means for the future.

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