Impact of increasing interest rates in 2018

As we have reported on multiple times, interest rates have been increasing and are projected to go even higher throughout the course of 2018. While no one knows exactly what the future will or won’t bring, all signs continue to put to the economy remaining strong over the short term…which leads to higher rates and several negative factors.

A strong economy is a double edged sword. It is great as it should lead to a continued, strong job market and maybe higher incomes. After all employers have been literally begging for qualified workers for at least 3 years.

But the downside to a strong economy is the likelihood of ever higher interest rates, which will lead to higher debt and loan payments for anyone that has borrowed money. Higher rates can also slow the economy so much that it leads to the next recession, which is bound to happen sooner or later due to the natural economic cycles.

We sometimes find it ironic in that most people want a super strong job market and economy. Then those households do such things as buy bigger and more expensive homes or cars, they feel good about the economy so maybe they take that next vacation, or spend money on the latest electronics, etc.

With a strong economy people tend to feel more secure in their jobs so they save less money and/or take out loans for that fancy car or home. Just look at the recently Bureau of Economic Analysis data in which the nation’s savings rate now stands at a 12 year low as of December 2017.

Risks of increasing interest rates

Interest rates almost always go up. Short term rates, which are controlled by the Federal reserve, lead to higher interest rates (and monthly debt payments) on revolving debt…including credit cards, auto loans, home equity, etc. Long term rates, which are more a reflection of investors expectations of higher inflation due to a strong economy, lead to higher rates for mortgages and corporate debt, among other things.

So what does all of this mean? If you have any resolving debt outstanding, such as credit card which is now at a record high as of January 2018, watch out! If the federal reserve raises rates 3-4 times this year (which many people expect) each and every increase leads to higher monthly payments.

If you are considering buying a home using a mortgage, also watch out! 10 and 30 year Treasury bond yields are increasing rapidly, and the increase is expected to continue. This will impact home loans.

Added into this mix of a stronger economy are other factors which may lead to higher rates…even if the economy were not to grow as quickly as many expect. And what are those factor?

One is central banks are pulling back on stimulus programs in 2018 and beyond. As an example, the US Federal Reserve is now in effect selling tens of billions of dollars of treasury bills and mortgage backed securities each month…and the pace will quicken each quarter. They are selling by allowing the bonds to mature and not reinvest the proceeds. This means those billions of dollars need to be covered by other borrowers. Other central banks may go back on their stimulus too.

The other factor is the increasing federal budget deficit. Some experts say the treasury may need to borrow up to 50% more money in 2018, which puts added pressure on interest rates. Much of that additional borrowing can be attributed to the Republican tax cut, with the higher cost to now refinance US debt leading to even more pressure.

This is obviously a high level summary of what may very well happen this year…and has been happening over the last several weeks. There are other factors too, but those are the main ones. But we have been warning of this for months by saying last year was the time to pay down debt, prepare for higher rates, etc.

The bottom line is a strong economy is not always a great thing to anyone in debt, as any wage increases given to a worker may just allow them to pay off higher interest costs.

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