Interest Rates and Unemployment

by Michael on Dec 13, 2012 · 2 comments

Image of Interest Rate Uncertainty

At long last, the Federal Reserve has finally given us a better indication of when we might expect interest rates to start to rise.

As long as inflation remains low, we can expect the Fed to work to keep interest rates near zero at least until unemployment drops below 6.5%, which could take until late 2015.

To do this, the Fed will continue spending $85B/month to buy bonds, including $45B/month on treasuries and $40B/month on mortgage-related bonds. The ultimate goal is to encourage borrowing and spending in hopes of spurring economic growth.

Of course, none of this will matter if the looming tax increases and spending cuts associated with the fiscal cliff come to pass. In fact, Fed Chairman Ben Bernanke has stated that uncertainty surrounding the fiscal cliff negotiations has already hurt the economy by reducing consumer and business confidence.

But with interest rates on mortgages and other loan products already at (or very near) all-time lows, it’s hard to imagine that maintaining these low rates will have much of an additional stimulative effect.

Instead, the low rates might shift investor behavior and drive people out of low-yielding bonds and into the stock market. If that happens and stock prices are driven up, people might start spending more and the economy would benefit.

My view on the latter point is this: Don’t let interest rates drive your investment allocation. Stocks and bonds aren’t the same thing. Not even close. So don’t let low interest rates bully you into taking on more risk than you would otherwise desire.


{ 2 comments… read them below or add one }

1 Edward Antrobus December 13, 2012 at 2:35 pm

I agree. I’m not comfortable with a lot of risk, so my retirement account is mostly bonds, bond mutual funds, and income mutual funds. I have a little growth mutual fund and no actual direct stock investment.

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2 The College Investor December 13, 2012 at 11:25 pm

Low interest rates will perpetuate the value of some investments, like REITs and other Real Estate investments. Could be as much of an opportunity as a burden.

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