So How High Will Interest Rates Go? Not Really That High
It’s axiomatic that higher interest rates are no friend of stock prices, especially those of tech firms. But how onerous will those rate hikes be? Not very.
Right now, the fed funds futures are indicating that the Federal Reserve likely will do four to five quarter-point increases in short-term rates this year and then two or three more in 2023, according to CME Group. If so, the central bank’s benchmark rate will stand at 1.625% by the end of next year.
That’s up from near zero now, a level that has held steady since the pandemic’s onset in March 2020. Before that, the rate was 1% to 1.25%.
Now, provided that economic growth isn’t falling into a ditch when current rates go up, odds are this won’t be much of a problem for the stock market. The reasons that higher rates quell stock price appreciation is that bigger interest tabs on borrowing can sap earnings growth. And tech companies in particular—which led the market rally till it petered out late last year—see their discounted cash flow shrivel, meaning they would make less money in the future. That’s not a good thing for a growth-oriented company and its shares.
True, corporate America’s debt payments are usually more keyed to longer-term borrowing costs. To wit, the 10-year Treasury note, now yielding just under 2%. This bond’s yield is determined more by macro forces than anything the Fed does with short-term rates. Until the pandemic hit, the long-term trend of the 10-year was down. Its highest yield over the last 10 years was just under 3.1% in mid-2018, when there was a temporary burst of economic energy due to the previous presidential administration's tax cut for companies, dropping the levy to 21% from 35%.
With the onset of massive government stimulus, the 10-year yield picked up. Note, though, that it hasn’t been sailing very high. Even with inflation roaring, now at a 7.5% rate, the T-note hasn’t budged much above 2%. What’s more, the futures market doesn’t show the 10-year’s yield rising much by June, according to CME Group.
A lot of what happens next to the 10-year hinges on forecasts for economic growth, which now are muted. Predictions are much lower than the 6.9% gross domestic product growth logged in 2021, the fastest since 1984. For 2022, the range of prognostications is wide, showing the degree of bafflement about how well and how fast the U.S. can shake off the ill effects of supply-chain bottlenecks and high inflation. There are some hints of improvement in the supply-chain mess, and higher prices haven’t deterred consumers from spending thus far.
The Atlanta Fed expects GDP growth to come in at a paltry 0.6% this year while Goldman Sachs puts expansion at 3.2% (albeit down from 3.8 previously). For much of the past decade, starting in 2010, growth was around 2% annually.
The chief reason that rates likely won’t shoot up much is that many people believe the current high inflation will abate. While it likely won’t fall to pre-COVID levels, it shouldn’t be much higher than historical norms, if investors’ bets tell us anything. The five-year inflation breakeven point (the difference between the five-year Treasury Inflation Protected Security (TIPS) and the five-year Treasury yields) is 3%.
This article was written by Larry Light from Forbes and was legally licensed through the Industry Dive Content Marketplace. Please direct all licensing questions to legal@industrydive.com.
