Higher for Longer

Interest Rates May Stay Higher for Longer. Here’s What That Means for Your Money.

If inflation were a hill, the top of the hill appears to be in the rearview mirror. However, the ride down the hill, especially at the bottom, has been a little bumpy. 

In June of last year, inflation hit 3.05% and has bounced around in the 3% range ever since. The Federal Reserve’s increasingly controversial 2% inflation target looks like it could be further away than some were imagining. The Atlanta Fed President has said the central bank should only cut rates once this year, and it is still possible the Federal Reserve does not cut rates at all in 2024. Interest rates may be higher for longer than expected. Here’s what that means for your finances.

Borrowing costs remain elevated

The cost to borrow money is largely determined by the benchmark interest rate set by the Federal Reserve. As the prospects for interest rate cuts in the near future have dimmed, borrowing costs have risen slightly. The average 30-year fixed mortgage rate at the end of last year was 6.65%, but it has recently risen to over 7% again. We are still well below the high last year of 7.94% in October, but the rise in mortgage rates is a sign that interest rates may remain higher for longer.

The stock market doesn’t seem to mind the potential for interest rates to remain elevated. The S&P 500 has set new all-time highs what seems like daily in 2024, and so far the index is up over 10% this year (normally 10% would be a good year for the market, but we’ve experienced that in a little over three months). The performance of the stock market is a sign the recent shift in interest rate expectations may not be cause for alarm, but those counting on interest rates to drop imminently may need to adjust course.

Make good financial decisions in the present, not the future.

What does that statement mean? It’s much easier to promise ourselves our financial decisions will be good in the future and make less-than-ideal financial decisions today. If you are buying a home right now, it could be tempting to stretch your budget now in the hopes that interest rates drop significantly in the next few years and allow you to refinance at a much lower rate. That could happen, but as the last couple months have shown, it is far from guaranteed.

This lesson can be applied to all areas of your financial life, not just those that have to do with interest rates. It is easy to overspend now if you are expecting a big raise or bonus at the end of the year. If you make good financial decisions now, and live as if interest rates will remain this high for the foreseeable future, or spend as if you aren’t getting a raise or bonus, it will make your life that much easier if those things do come to fruition.

Will interest rates drop in 2024?

Even if interest rates are expected to drop this year, which appears to still be likely, nothing should be counted on. Earlier this year, prediction markets suggested a greater than 90% chance the Federal Reserve cut rates two or more times in 2024. Now, prediction markets say there is only about a 64% chance that rates are cut two or more times this year. The chances of rate cuts change quickly, and depending on how hot or cold new inflation and jobs data comes in, the chances for rate cuts this year could dramatically increase or decrease. Your financial life should not be dependent on either outcome, good or bad. 

When interest rates are cut, which will happen eventually, it will be stimulative to the economy. The cost to borrow money will be lower, which incentivizes people to borrow money to start businesses, buy homes and cars, hire more employees, and so much more.

What if interest rates don’t drop soon?

Life would be so much easier if we all had financial crystal balls that could tell us when the stock market is going to go up and down and when rates are going to drop or go up. Nobody can predict the future, but that doesn’t keep people from trying (one blatant example in recent history is Bloomberg Economics forecasting a 100% chance of a recession in the next 12 months…back in October of 2022). The good news is you don’t need to be able to predict if the stock market will be higher in 6 months or 12 months or if interest rates will be lowered this year. It is possible to prepare your financial life and investment portfolio for whatever the financial world throws at you.

What does that mean? In practice, it usually means reducing risk whenever it makes sense to do so. A 25-year-old could reduce their risk of losing money in the stock market by parking all of their money in a savings account, but it may not make sense to do so - over time, they could lose out on millions in compounding interest. On the other hand, someone close to retirement may want to reduce risk in their portfolio by shifting their investment allocation and building more cash reserves as they get closer to retiring. In this case it likely makes sense to take risk reduction measures since the risks (not being able to retire and having to work longer, or “dying broke,” are so much worse).

At Aberdour Investments, I help clients optimize their financial lives to prepare for the unexpected. It will never be possible to be prepared for everything, but the more you recognize your risks, and take steps to reduce risk where it makes sense, the greater your chances of success could be, whether you are starting a business, planning for retirement, or buying your first home. If you want to learn more about how I work with clients, please reach out - I’d be happy to chat!