The Real Interest Rate Worry

Submitted by Brenda P. Wenning on Monday, October 20, 2014 - 9:00am
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Should we fear rising interest rates? Even the thought of them throws the stock market into a spin. The real problem with climbing rates, though, is that they will make servicing the out-of-control federal debt even more expensive.

For most investors, the focus is on what damage higher rates may inflict on stocks. There has been much market panic of late over the possibility that the Federal Reserve will raise rates sometime in the not-too-distant future.

Small-capitalization stocks were the first casualty of this talk. The large-cap Standard & Poor’s 500 is still up 2.13% for the year, while the Russell 2000, the benchmark for small stocks, is down 5.74%. Smaller companies have less flexibility and fewer resources, thus higher borrowing costs vex them more than they do mega-corporations.

While up more than 40% year-over-year at the end of December, the Russell index fell into correction territory in early October, meaning it was off more than 10% from its March high.

As The Wall Street Journal explained, “Given that periods of market turmoil tend to buffet small stocks more than their larger counterparts, many investors in small companies are fearful as the Federal Reserve moves toward raising interest rates. Even investors hopeful for small stocks are proceeding with caution.”

Yet should the markets be this skittish over interest rates? Not really.

In September, Fed Chair Janet Yellen announced that interest rates will remain low for “a considerable time” even after quantitative easing (QE), the Fed’s bond-buying program, ends. This stimulus program is scheduled to end this month, but could be extended.

Economic data continue to be mixed. The official U-3 unemployment rate dropped to 5.9%, but the percentage of Americans participating in the workforce is at a 36-year low. Jobs are increasing, but four out of five of them are for low or minimum wages. So QE could be extended, since its alleged purpose is to help the economy grow.

Even if QE ends this month, the “considerable time” Yellen cites could, indeed, be considerable, given the consequences of raising interest rates. As rates rise, it’s unlikely that the Fed can continue to push the stock market to new records. 

What’s even more important is that higher rates will have additional consequences, particularly a huge impact on U.S. debt. Federal debt has reached $17.7 trillion.

Consider that the average rate of interest on the government’s marketable debt in August was just 2.028%, while in January 2000 it was 6.62%. If interest rates rise back to the level they were at in 2000, the U.S. will need to pay more than $1 trillion a year just in interest payments.

That’s money that does not pay for educating our kids, supporting our health care system, fixing our infrastructure or keeping the country secure. It buys nothing. It only keeps our federal government operating – and continuing to rack up more debt.

You may have heard that President Barack Obama and the U.S. Congress have the federal deficit under control. In relative terms, perhaps. Remember the budget cuts that took place because of sequestration? According to the U.S. Treasury, the federal government officially ran a deficit of $589 billion for the first 11 months of fiscal year 2014. That’s an improvement from previous years, in which the deficit exceeded $1 trillion.

But according to U.S. Treasury numbers, on Sept. 30, 2013, the U.S. national debt was $16.7 trillion. So if the deficit is in check, how come the debt is now more than $1 trillion higher? 

 

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As Michael Snyder notes in his “Economic Collapse” blog, the $589 billion deficit number “is just for public consumption and it relies on accounting tricks which massively understate how much debt is actually being accumulated.”

Already, the United States has more government debt per capita than Greece, Portugal, Italy, Ireland or Spain. It’s not always good to be No. 1.

Federal debt does not receive the media attention of issues such as climate change, which may or may not have a negative impact on future generations. But it is a certainty that your children and their children will see their quality of life erode significantly unless something is done to control the federal debt.

If you love your children, you may want to ask your congressional representatives to do something about the federal debt.

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Brenda P. Wenning is president of Wenning Investments LLC in Newton, Mass. 

AdviceIQ delivers quality personal finance articles by both financial advisors and AdviceIQ editors. It ranks advisors in your area by specialty, including small businesses, doctors and clients of modest means, for example. Those with the biggest number of clients in a given specialty rank the highest. AdviceIQ also vets ranked advisors so only those with pristine regulatory histories can participate. AdviceIQ was launched Jan. 9, 2012, by veteran Wall Street executives, editors and technologists. Right now, investors may see many advisor rankings, although in some areas only a few are ranked. Check back often as thousands of advisors are undergoing AdviceIQ screening. New advisors appear in rankings daily.

 

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