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Rising Inflation and Interest Rates: What You Need to Know

By April 27, 2021August 30th, 2021No Comments

For the first time in a long time, rising inflation and rising interest rates are in the news.

Consumer prices jumped 2.6% in March, the biggest increase since August of 2018. And last month, the 10-year Treasury yield hit 1.75%. While the benchmark bond’s yield has since retreated to near 1.6%, it’s still well above its .5% level of August 2020.

Headlines about rising inflation and interest rates may seem scary to some, if only because both inflation and rates have been so low for so long. Hyperbolic headlines don’t help. So we thought we’d share our perspective on inflation and interest rates as well as what actions, if any, you should take.

First, let’s look at what’s causing the pickup in inflation. In a word, demand for goods and services is rising faster than supply, which is causing prices to rise. Driving consumer demand: vaccinations, business reopenings, trillions of dollars in federal stimulus spending, and ample consumer savings.

How is inflation related to interest rates? Bond investors keep an eagle eye on inflation because rising prices eat into the purchasing power of bonds’ fixed interest payments. As bondholders sell, bond prices readjust downward. And that drives up yield—which is the amount of interest a bond pays relative to its price.

Long-term yields, in turn, are used as a benchmark by mortgage lenders. As yields rise, lenders raise the interest rates they charge borrowers. And that’s where you might feel the impact. Interest-rate increases of just a point or two can significantly affect both monthly payments and total payments over a loan’s lifetime.

A borrower with a $500,000, 30-year mortgage at 2.75%, for example, will pay $2,041 per month and $734,834 over the life of the loan. For the same loan with an interest rate of 3.75%, the borrower will pay $2,316 per month and $833,608 total – meaning that a single extra percentage point of interest adds nearly $100,000 to the cost of the loan.

So far, inflation and interest rates are still historically low. Some Federal Reserve officials expect the pickup in inflation to be transitory. But it’s still a good idea to evaluate the timing of real estate purchases. Your financial advisor can help you understand the potential impact of buying versus waiting and how a mortgage fits within your budget and affects your financial plans.

It’s important to understand that rates on home-equity loans may not rise in tandem with mortgage rates. That’s because home-equity rates are geared to short-term rates controlled by the Fed, and the central bank has signaled it will keep such rates low indefinitely.

Rising bond yields can also stir up stock market volatility. Stock prices, in general, have remained high following the market’s 2020 runup. And the more robust yields on safe Treasury bonds have caused a certain number of investors to sell stocks and buy bonds. As stocks trade down, opportunistic equity buyers smell bargains and snap them up. The result: markets that rise and fall from one day to the next.

Volatile markets underscore the value of diversified investment portfolios, like those created by AdvicePeriod. Diversified portfolios comprise a mix of asset types to capture market returns while limiting exposure to any single asset or risk. It may be tempting to jump from asset to asset, including exotic alternative investments, in a hunt for yield and total return. But diversified portfolios have been proven to produce higher long-term returns, with less risk, than any individual investment type.

AdvicePeriod complements portfolio diversification with regular rebalancing – adjusting the mix of holdings in your portfolio to remain in line with your investment goals and risk tolerance. Rebalancing can further reduce portfolio volatility and can potentially increase returns over time. So when it comes to investing, if your goals and risk tolerance have remained the same, the best thing to do might be to do nothing.

Don’t hesitate to contact your financial advisor to discuss investments, mortgages, or any other financial topic.