Once upon a time, high interest rates were a fact of life.
Now, I don't mean 8%-high, I mean really high. Back in the early 1980s, "high interest rates" meant double digits. As those of you of a certain age will recall, mortgage rates peaked at a bit over 18% in October 1981.
One might think of that peak as the bottom of a bear market -- a bear market in affordable loans, as it were. Now consider: We've had a 28-year-plus rally off that bottom. Sure, interest rates gone up and down in fits and starts over the years, but the overall trend was down, down, down -- right up (or down) to the Fed's dramatic interest rate cuts in the wake of the banking crisis and market crash.
You'll note, however, that rates have been slowly but surely starting to rise in recent months. And you know what happens after bull markets peak, right?
It's possible that the era of cheap credit is over.
Why this particular bear may be waking up
As I see it -- and I'm hardly the only one -- there are two forces that are likely to push interest rates higher in the coming months and years:
- The national debt. The U.S. government finances its debt by selling Treasury bonds of various kinds. When demand for those bonds is high, as it was during the credit crisis, interest rates go down. As investors have turned away from government securities and back toward investments like corporate bonds and stocks, demand has fallen. As rates for things like mortgages and auto loans are typically linked to long-term Treasury rates, falling demand for the bonds has caused loan rates to rise.
- Inflation risk. The dramatic increase in the money supply since the advent of the banking crisis has led many to believe that inflation is inevitable. Inflation puts upward pressure on interest rates as well -- in an environment where money is declining in value over time, lenders expect to be compensated for that decline, over and above their usual rate of interest.
There's additional upward pressure on mortgage rates right now, coming from the Federal Reserve's decision to end its $1.25 trillion mortgage-debt buying spree. Lenders now have to find private buyers for mortgage debt, or hold it themselves.
While we may not see a return to the extreme rates seen in the early 1980s, it seems likely that we'll be seeing higher rates than we're used to -- and they may hang around for a while.
And here's my question: As this increase starts to unfold, what will happen to the recovery?
Adjusting to a more sober reality
What happens to Ford's
Or from another perspective, what happens to the major lenders? How will Bank of America
And what if credit card delinquencies go even higher as rising interest rates make minimum payments harder for the cash-strapped to make? American Express
I could keep listing companies affected by rising interest rates all day. So could you, if you think about it -- increases in the cost of capital affect nearly every business on some level. But some are affected more than others. A recent review by Standard & Poor's found that technology companies -- which typically don't do a lot of borrowing -- tend to outperform other sectors after Federal Reserve rate hikes, for example.
Rising interest rates do come with a few silver linings. While the bond market generally suffers during periods when rates are rising, short-term investments like money market funds look more attractive as they start paying more than token yields. And rates on short-term CDs -- largely ignored by many investors in recent years -- may finally start to look attractive again to those leery of the bond market.
And if large investors start dumping bonds and buying stocks, that could help mitigate inflation's effects on the broader market. But one way or another, even if inflation is held at bay for awhile, rising interest rates seem all but inevitable. As you look at investment opportunities, keep asking yourself: How will rising interest rates affect this?
And if you don't like the answer, consider investing elsewhere.
Worried about inflation and higher taxes? Read Dan Caplinger's view on the key decision to make this week.
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Fool contributor John Rosevear owns shares of Ford. American Express and Discover Financial are Motley Fool Inside Value choices. Ford is a Motley Fool Stock Advisor recommendation. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.