by Matthew Durkee, New England President, Community Bank In the current economic landscape, interest rates have emerged as a focal point that is driving discussions and shaping financial decisions. Predicting their trajectory is inherently challenging and subject to various factors and uncertainties.
Interest rates have been on the rise since early 2021, when the injection of significant government stimulus funds contributed to a sharp rise in market liquidity and an increase in the inflation rate. In an attempt to tame inflation, the Federal Reserve increased its various borrowing rates, and these were passed to the public through higher borrowing costs at banks and other lending institutions.
While rates can vary between lenders, that variance is generally within a small spread that is consistent across the country.
Markets viewed the recently passed Fiscal Responsibility Act of 2023 as positive news, and rates fell slightly. However, long-term rates (10 years) continue to be lower than short-term rates (2 years), commonly referred to as an inverted yield curve. This is generally viewed as a predictor that the economy will slow and rates will eventually fall. There is no crystal ball but the current expectation is that the federal government will raise rates in July before dropping them toward the end of 2023.
The current rising interest rate environment — driven by the need to combat inflation — creates challenges and opportunities for individuals, businesses and governments alike. Interest rates were at historical lows for an extended period of time, but the current inflation crisis required rates to rise.
Be mindful that debt never sleeps; interest accrues on any outstanding debt, every day, whether a weekday, weekend or holiday.
A way to reduce concerns about interest rates is to carry as little debt as possible.
Weathering the interest-rate landscape requires a strategic approach to managing your finances and investments. Here are some strategies for consideration to navigate the changing environment:
- Evaluate your financial position: Start by assessing your current situation, including your income, expenses, savings and debt obligations. Understanding your financial standing will help you make informed decisions about borrowing, saving and investing.
- Review your debt: If you have variable-rate debts, such as adjustable-rate mortgages or variable-rate loans, consider the potential impact of rising interest rates on your monthly payments.
- Build an emergency fund: Establishing an emergency fund is crucial in any economic climate, but it becomes even more important during periods of rising interest rates. The general guideline is to have six months of your normal monthly expenses saved.
- Evaluate bond investments: Higher interest rates can make fixed-income investments like bonds more attractive than stocks, but rising interest rates can negatively affect the value of existing bonds, particularly those with longer maturities. Review your portfolio and consider shorter-duration bonds that are less sensitive to interest-rate changes. Additionally, consider diversifying your fixed-income investments by including bonds with varying credit qualities and issuers.
- Reassess your mortgage and real estate plans: If you are considering purchasing a home or investing in real estate, analyze how rising interest rates may impact affordability and property values. Higher interest rates could result in higher mortgage payments, so factor this into your budget and long-term financial planning. If you believe rates will fall in the future, one way to pay a lower rate on a home mortgage is to take out an adjustable-rate mortgage (ARM), which provides a fixed-rate period (3, 5, 7 or 10 years) and then adjusts to the then-current rate environment. For the initial fixed rate period, these rates are generally lower than the current traditional 30-year fixed-rate mortgage.
- Reevaluate the use of credit cards to make monthly purchases. Unsecured loans are accessed at much higher interest rates, so reserve credit card purchases for items that will be paid off monthly. Consolidating consumer debts into a single amortizing note can often achieve a lower interest rate.
- Seek professional advice: Consider consulting with a financial advisor who can provide personalized guidance based on your specific financial goals, risk tolerance and the current interest-rate environment. Community Bank, and many others, champion local businesses and individuals and provide guidance to help navigate the ups and downs of economic cycles.
In this evolving interest rate environment, careful analysis, nimble strategies and a keen eye on global economic dynamics are helpful to capitalize on opportunities while effectively managing risks.