Getting control of your financial future for young people, Chapter 2: Why you need to understand and pay attention to interest rates.
To manage your own money properly, you need to understand several key things that determine major moves in the market. Understanding these few factors will make you some money, but more importantly, it will help prevent you from losing LOTS of money.
One of the most critical things to at least be aware of is interest rates. They are the key driver of the global bond market, which at $80T, almost doubles the size of the global stock market. The bond market is one of the most powerful forces on earth. I am reminded of a famous quote by James Carville, President Clinton’s chief advisor when the bond market resisted economic plans by the administration.
Carville said: I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.
There are a number of different key interest rates, but they all essentially measure the same thing, the cost of borrowing money. One rate that everyone should be aware of is the 30 year fixed mortgage rate, which determines the cost of borrowing to buy a home. You can see that rates have been dropping for 30 years, in sync with other rates, which is behind the fact that bonds have been great investments during that time (bond prices go up when interest go down and vice versa)
Here is a great chart showing the 30 year mortgage rate, compare to the Prime Interest Rate (widely used by financial institutions for loans of many types)
So you can plainly see that rates are at historic lows, and they cannot be below zero. Obviously, make sure that you don’t have investments that will be hurt by the inevitable reversal of interest rates back to historical norms. The primary negative pressure will be on long term bonds, which in the past two weeks have been dramatically hit. Bonds suggest safety, they are anything but when interest rates are moving up. Income investments such as preferred stock and utilities have also been hit, as investors wait for some predictable stability in interest rates. These investments have been very secure for decades, but as Bill Gross of Pimco has said: “the 30 year bull market in bonds is over”. Tread carefully, and if you are not sure, sell or don’t buy these kinds of investments until there is rate stability.