“Me I take the hand I’m dealt... And play it as it lays; it’s the cost... of living, and everyone pays."
—from “The Cost of Living,” as performed by Don Henley
Want to borrow to expand your business? Want to buy property or financial assets using leverage? It’s going to cost you more than it did the last few years
The Federal Reserve has signaled its intent to continue raising interest rates and there will almost certainly be some short term negative consequences attached to their actions.
Business expansion and investment will be somewhat curtailed, which will have knock-on effects in the stock market. Businesses tend to borrow less when it costs more to do so. In recent years, cheap money has encouraged corporations to borrow heavily to reinvest in their own companies through stock buybacks. Buybacks tend to increase earnings per share over time and also provide support for the stock price, because other investors know that the company itself is buying stock and want to tag along.
With rates going up, many companies won’t find the process of borrowing money to buy back stock as attractive as they did when rates were lower. Without the buyback mania of the last few years the stock market’s results may have looked very different. Knowing this, it’s not surprising that the last two sharp stock market declines coincided with “blackout periods” when corporations temporarily halted their buyback programs.
Here’s the catch: this isn’t all bad news. Why? Because the fact that the Federal Reserve is staying the course with raising rates means that our central monetary body has long term confidence in the U.S. economy. The ultimate goal for economic policy makers for the past decade has been to build an economy which doesn’t need to rely on quantitative easing, zero or extremely low interest rates, and special government programs.
The current fed funds rate, which sets the bar for other rates in the U.S., is a little over 2 percent, which is a whole point higher than it was this time last year. And the Federal Reserve has indicated that within two years it hopes to reach around 3.5 percent. So, barring any major economic crisis, borrowing will continue to become pricier.
We may or may not ever see future borrowing and mortgage rates as low as they were two or three years ago. Regardless, getting the economy used to a more normal borrowing and lending environment is a good thing.
It means we’re finally getting back to economic normality, which was suspended for the past decade. Let’s hope it lasts.
Margaret R. McDowell, ChFC®, AIF®, author of the syndicated economic column “Arbor Outlook,” is the founder of Arbor Wealth Management, LLC, (850.608.6121 – www.arborwealth.net), a “fee-only” registered investment advisory firm located near Sandestin.