How low interest rates may affect your clients

We are living in an extraordinarily low-interest-rate environment, and with the Federal Reserve’s intentions of keeping rates near zero through at least 2023, there’s no telling when, or if, mid-single-digit, let alone double-digit rates will ever return.          

Long-term interest rates normally rise as the U.S. economy recovers from a recession, but in this cycle, the uptick should be counterbalanced by the increased interest-rate sensitivity of the economy as the debt levels of consumers, businesses and the nation are at record levels. In addition, Scott Brown, Raymond James’ chief economist, offers that “a sharp rise in long-term interest rates will be prevented by the Federal Reserve.”

Low interest rates have been problematic for savers hoping to earn enough interest on cash reserves to combat inflation, but those yearning for higher yields may want to be careful what they wish for. A drastic rise in rates would not bode well for longer-duration bonds, mortgage rates and equity market valuations, just to name a few, in the near term. Sometimes, rather than wishing for a different environment in the markets, investors need to step back and assess the potential opportunities at hand in light of their specific needs and financial situation.

RETIREES

A pandemic-stricken economy and an aging population, with 10,000 baby boomers turning 65 every day according to Pew Research, are not an ideal combination. For those nearing or currently in retirement, and for diligent savers of any age bracket, the Fed’s decision to keep interest rates lower for longer has triggered a hunt for yield.

With Treasuries not yielding much, and CDs and money-market accounts following suit, investors in search of yield are left with options such as lowering their desired credit quality or possibly abandoning traditional fixed-income investments in favor of dividend-paying equities.

Before the risk profile is adjusted, it's important to consider the true function of fixed income within a portfolio, and the functions of safety and predictability may far overshadow a slight difference in yield. This may be even truer if goals such as retirement are on the horizon. In the year ahead, we expect bonds to offset the potential for equity volatility rather than produce robust capital returns. While the returns may be dismal, the value of principal preservation — the return of money rather than the return on money — must be assessed by the individual investor. Ultimately, with a thoughtful, documented retirement strategy intact, the ripple effect of rates can be dutifully managed.    

Bottom Line:
• The COVID-19 pandemic has altered the investment landscape, and investors would be best served by an adviser who understands the breadth of their client’s financial situation. While the equity market has recovered more than its losses and yields have fully recovered, the events over the last 14 months may have shifted portfolio goals and objectives. At a bare minimum, the pandemic-induced volatility should still be used as a reference point for recalibrating risk tolerance moving forward.

SMALL BUSINESS CLIENTS

In March 2020, the Fed slashed the fed funds rate, which anchors short-term interest rates, to between 0.00% and 0.25% in an attempt to stimulate the economy and encourage spending.

In this low-rate environment, small business owners with high creditworthiness should assess their current business model and identify both weaknesses and opportunities. Perhaps the most important lesson from the COVID-19 pandemic: Is there a backup plan, including a source of funding should the business be interrupted again for some reason? According to the Fed, the virus-induced recession resulted in the loss of 200,000 businesses in excess of normal levels, so it may serve as a lesson to always prepare for the unexpected.

This question alone may spark a deeper conversation related to expansions into new markets more resilient to shifts in individual spending, the ability to buy larger volumes of inventory, consolidation of prior debts, and the preparedness for an increase in business activity as the economy improves, and the discussion may reveal a need for financing options at an opportune time in the market.

Stimulus plans have made traditional lending more difficult as larger banks are stretched administratively. But as Paycheck Protection Program loans are refunded, there are opportunities for small businesses to access capital through stimulus programs facilitated by local banks. Even if no action is needed at this time, it may be beneficial to explore the possibility of how new capital or a line of credit could alter the appeal of proposed business initiatives.

Bottom Line:
• Small business clients should schedule a balance-sheet review to manage opportunities or unexpected expenses.

HOMEBUYER CLIENTS

Historically low mortgage rates, the work-from-home phenomenon and demographic trends (e.g., the peak of the nation’s largest generation — millennials — turned 30 in 2020) have created insatiable demand in the U.S. housing market, according to Raymond James analyst Buck Horne. The demand has been broad too, from first-time homebuyers to affluent clients desiring a second home or wishing to help their children purchase a home.

With more buyers entering the market, and current active listings plummeting more than 50% to record lows since last March, the U.S. housing market is now nearly 4 million homes short of buyer demand, versus just 2.5 million in 2018, according to the Federal Reserve and Freddie Mac.

Bill Geis, head of private client group banking at Raymond James, says this has created a “need for more and more clients to become cash buyers,” using bridge loans to secure the home and then mortgaging it later on, to gain an advantage in bidding wars. But this strategy raises the question of which investment or savings accounts should be utilized for the draw.

It's not all tailwinds for the housing market though. The Urban Institute’s housing credit availability index hit a low in 2020, meaning that borrowers with less than perfect credit are having trouble obtaining a mortgage. The pandemic also brightened the appeal of aging in place for seniors, which has contributed to the paltry housing supply. As a result of these factors, the American dream of owning a home, one of the primary methods of building financial security, remains exactly that for some hopeful buyers despite record low rates.

Bottom Line:
• Homebuyers should assess liquidity sources with their advisers to ensure they can act quickly on buying a home that is well aligned with their long-term budget.
• Homeowners should be mindful of refinancing opportunities and recoup income if possible.

Larry Adam is chief investment officer at Raymond James.