US Federal Interest Rates

Today the US Fed raises the rates from 2% to 2.25%. The stock market has been embroiled in a sea of red declines since October and the rising benchmark borrowing interest rate has been blamed as one of the causes.

Actually the long term trajectory of the interest rates has been on decline since 1980. But since 2009 they have been near zero.

If people had lived with far higher rates in the past why is there so much anguish with a 2.25% interest rate these days?

Historical US Fed Rates

The main difference then and now is the amount of debt that is out there now. The US debt to GDP ratio back in 1980 was 32.5%. Today it has tripled to around 108%.

To keep the interest payment to GDP ratio the same today as back in 1980, the interest rate cannot be higher than 1/3 of what it was in 1980 given that the debt to GDP ratio has already risen 3 folds.

That’s why people get worried as the US Fed will continue to raise rates 2 more times in 2019 up till 2.75%. That’s pretty close to 1/3 of the rates in 1980. Excessive interest payments will mean that governments will have less to spend on development and social programs or worse still forced to raise taxes.

Additionally a lot of companies have been borrowing money during the years of ultra low interest rates. Once these debts mature, companies will have to pay more if they wish to rollover the debts.

No one expects the government debt level to go down. This can only mean that in the long term interest rates will continue to go down. The current increase in interest rates is still in line with its long term downtrend.

This however spells bad news to long term bond holders and people keeping cash savings in FD/CD and money market funds.

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