we may not see interest rates so low again during our lifetimes
Averaged over the calendar year, the Federal Funds rate was lower during 2021 than during any other year on record (going back to 1955). [This is the overnight interest rate between banks, set by the Federal Reserve.]
2021: 0.08%
The overnight interbank rate in the UK was also the lowest ever in 2021, but they have comparable records going back to the 17th Century. Taking a millennial view of the historic data, typically overnight interest rates fluctuate between 2-5%. The extremes outside of this range occur when an economic depression cuts rates to near zero, or when high inflation pushes rates significantly higher. But the extreme interest rate swings we've seen over the past 100 years depend crucially upon our abandonment of the historic gold standard. You couldn't cut interest rates to near-zero without flooding the economy with newly printed cash, and you couldn't reach interest rates above 10% without having first suffered years of high inflation due to flooding the economy with newly printed cash. The gold standard kept interest rates (and inflation) within a tighter collar, although it also produced more frequent financial panics, especially after the Industrial Revolution.
[Some short-term interest rates were almost as low during the Great Depression as they were last year. Almost. Maybe for all practical purposes they were as low. I think the main difference between now and then is that interest rates used to be listed in fractions of a percent, but now we list them in hundredths of a percent. This set a practical floor of 1/4% during the 1930s whereas now the floor is theoretically 0.01%. You must be pretty old to have personal memories of interest rates being as low as they are now.]
There's no reason to think interest rates will stay this low. The Federal Reserve expects to increase interest rates multiple times during 2022, the only questions are how soon, how often, and how much. The futures market expects the Federal Funds rate to increase to 0.93% over the next year. Still low, but over 10x what it was last year.
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Although interest rates bottomed out at all-time lows last year, we've been blessed by unusually low interest rates since 2008, since the financial crises of 2008-2009 nearly flattened the global banking industry. If central banks had not responded to these financial crises by printing mountains of new cash and stuffing that new cash into the vaults of private banks, we would've suffered thousands of bank failures and another Great Depression. Instead, we got by with what people call the Great Recession. Citibank did not fail, Bank of America did not fail, Wells Fargo did not fail -- they were expertly bailed out.
The Great Recession was followed by the longest economic boom in US history, fueled by consistently below-normal interest rates and the most generous federal budget deficits since WW2. Before the COVID pandemic fucked things up, we were experiencing the lowest unemployment rate in 50 years, after 10 years of solid stock market gains -- with not a single "bear market" decline. If you were born after 1990, you didn't know what a bear market felt like.
The Federal Reserve was trying to normalize interest rates back to the historic 2-5% range when the pandemic hit. The pandemic led the Federal Reserve and Congress to outdo their Great Recession stimuli; instead of stuffing new cash into bank vaults, they sprayed new cash throughout the economy, sent checks to families and businesses, and bought securities on the open market. Interest rates in many countries hit the lowest levels ever seen by humankind, even dropping below zero in fiscally strong countries like Germany and Switzerland. This had NEVER happened before.
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Now the US economy has recovered from the pandemic in almost every way -- except that a few million people have not returned to the labor market -- they may have retired, gone back to school, switched to providing child care, opened their own business, etc. The unemployment rate is back below 4%, the stock market is within a few percent of its all-time high, real GDP exceeds the pre-pandemic high, corporate profits are skyrocketing (highest ever as a portion of GDP), real estate prices are soaring, and even nonsupervisory wages are growing faster than in 40 years.
Yes, inflation has also jumped to a 40-year high, and there are shortages of certain goods and services, but these should be expected side effects of the kind of economic boom we're having, given the tremendous amounts of economic stimuli generated by the US government over the past two years.
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So what next?
When the economy is booming like this, with unemployment below 4% and inflation at 7%, with both stock prices and real estate prices in bubble territory, with corporate profits at record highs -- interest rates must go up. Interest rates absolutely have to go up!
The biggest economic story of 2022 and probably for the next few years will be that interest rates absolutely have to go up.
The difficult part of the story is how high interest rates will go.
Those of you born after 1990 who entered adulthood after the Great Recession are going to experience some things for the first time. The rest of us are going to experience some deja vu.
As interest rates go up, corporate profits will be squeezed, and stock valuations will be squished. It is likely that stock prices will decline in 2022 and maybe into 2023 and even 2024. When stock prices are in bubble territory, they can decline for two or three years in a row.
Housing prices may also plateau or even tumble, though maybe not as quickly as stock prices, because houses are not traded on an open market -- it depends on how quickly interest rates rise. Mortgage rates were the lowest on record in 2021, averaging below 3%. We may never see mortgage rates so low again. That will affect housing affordability, even as wages continue to rise.
People who need to save money will earn higher interest rates, but people who need to service high debt levels will get squeezed. The US federal government, the largest borrower on the planet, will see its interest expense rise, putting pressure on its already wide budget deficit. [The second-largest borrower on the planet is the government of Japan.]
Interest rates must move back toward the normal 2-5% range, and may even move higher to combat inflation. I think most households, businesses, and governments are not prepared for this shift. This will create volatility in the financial markets and in our political arenas. Central bankers may need to push the economy into a recession to combat inflation. Take a look at your household or your organization, and think about how higher interest rates will affect you. Don't be caught by surprise. Lock in low rates, pay down variable-rate debt, sell off some of your high-flying stock or real estate investments, and expect less generosity from your governments. Don't wait until the panic. Don't wait until Wile-E-Coyote looks down.
2021: 0.08%
The overnight interbank rate in the UK was also the lowest ever in 2021, but they have comparable records going back to the 17th Century. Taking a millennial view of the historic data, typically overnight interest rates fluctuate between 2-5%. The extremes outside of this range occur when an economic depression cuts rates to near zero, or when high inflation pushes rates significantly higher. But the extreme interest rate swings we've seen over the past 100 years depend crucially upon our abandonment of the historic gold standard. You couldn't cut interest rates to near-zero without flooding the economy with newly printed cash, and you couldn't reach interest rates above 10% without having first suffered years of high inflation due to flooding the economy with newly printed cash. The gold standard kept interest rates (and inflation) within a tighter collar, although it also produced more frequent financial panics, especially after the Industrial Revolution.
[Some short-term interest rates were almost as low during the Great Depression as they were last year. Almost. Maybe for all practical purposes they were as low. I think the main difference between now and then is that interest rates used to be listed in fractions of a percent, but now we list them in hundredths of a percent. This set a practical floor of 1/4% during the 1930s whereas now the floor is theoretically 0.01%. You must be pretty old to have personal memories of interest rates being as low as they are now.]
There's no reason to think interest rates will stay this low. The Federal Reserve expects to increase interest rates multiple times during 2022, the only questions are how soon, how often, and how much. The futures market expects the Federal Funds rate to increase to 0.93% over the next year. Still low, but over 10x what it was last year.
-----
Although interest rates bottomed out at all-time lows last year, we've been blessed by unusually low interest rates since 2008, since the financial crises of 2008-2009 nearly flattened the global banking industry. If central banks had not responded to these financial crises by printing mountains of new cash and stuffing that new cash into the vaults of private banks, we would've suffered thousands of bank failures and another Great Depression. Instead, we got by with what people call the Great Recession. Citibank did not fail, Bank of America did not fail, Wells Fargo did not fail -- they were expertly bailed out.
The Great Recession was followed by the longest economic boom in US history, fueled by consistently below-normal interest rates and the most generous federal budget deficits since WW2. Before the COVID pandemic fucked things up, we were experiencing the lowest unemployment rate in 50 years, after 10 years of solid stock market gains -- with not a single "bear market" decline. If you were born after 1990, you didn't know what a bear market felt like.
The Federal Reserve was trying to normalize interest rates back to the historic 2-5% range when the pandemic hit. The pandemic led the Federal Reserve and Congress to outdo their Great Recession stimuli; instead of stuffing new cash into bank vaults, they sprayed new cash throughout the economy, sent checks to families and businesses, and bought securities on the open market. Interest rates in many countries hit the lowest levels ever seen by humankind, even dropping below zero in fiscally strong countries like Germany and Switzerland. This had NEVER happened before.
-----
Now the US economy has recovered from the pandemic in almost every way -- except that a few million people have not returned to the labor market -- they may have retired, gone back to school, switched to providing child care, opened their own business, etc. The unemployment rate is back below 4%, the stock market is within a few percent of its all-time high, real GDP exceeds the pre-pandemic high, corporate profits are skyrocketing (highest ever as a portion of GDP), real estate prices are soaring, and even nonsupervisory wages are growing faster than in 40 years.
Yes, inflation has also jumped to a 40-year high, and there are shortages of certain goods and services, but these should be expected side effects of the kind of economic boom we're having, given the tremendous amounts of economic stimuli generated by the US government over the past two years.
-----
So what next?
When the economy is booming like this, with unemployment below 4% and inflation at 7%, with both stock prices and real estate prices in bubble territory, with corporate profits at record highs -- interest rates must go up. Interest rates absolutely have to go up!
The biggest economic story of 2022 and probably for the next few years will be that interest rates absolutely have to go up.
The difficult part of the story is how high interest rates will go.
Those of you born after 1990 who entered adulthood after the Great Recession are going to experience some things for the first time. The rest of us are going to experience some deja vu.
As interest rates go up, corporate profits will be squeezed, and stock valuations will be squished. It is likely that stock prices will decline in 2022 and maybe into 2023 and even 2024. When stock prices are in bubble territory, they can decline for two or three years in a row.
Housing prices may also plateau or even tumble, though maybe not as quickly as stock prices, because houses are not traded on an open market -- it depends on how quickly interest rates rise. Mortgage rates were the lowest on record in 2021, averaging below 3%. We may never see mortgage rates so low again. That will affect housing affordability, even as wages continue to rise.
People who need to save money will earn higher interest rates, but people who need to service high debt levels will get squeezed. The US federal government, the largest borrower on the planet, will see its interest expense rise, putting pressure on its already wide budget deficit. [The second-largest borrower on the planet is the government of Japan.]
Interest rates must move back toward the normal 2-5% range, and may even move higher to combat inflation. I think most households, businesses, and governments are not prepared for this shift. This will create volatility in the financial markets and in our political arenas. Central bankers may need to push the economy into a recession to combat inflation. Take a look at your household or your organization, and think about how higher interest rates will affect you. Don't be caught by surprise. Lock in low rates, pay down variable-rate debt, sell off some of your high-flying stock or real estate investments, and expect less generosity from your governments. Don't wait until the panic. Don't wait until Wile-E-Coyote looks down.