Where Are Interest Rates Headed?

Welcome and thank you for joining the Informed Investor. Today's topic is the granddaddy of them all, interest rates. I'm Mark Gochnour, I'll be joined today by Jake DeKinder and Dr. Wes Crill. And I said, "They're granddaddy." You're so excited. I'm so excited. And maybe it's not the granddaddy, maybe it's the daddy, the step daddy, something. This sounds like a therapy session you got there. Family issues. I mention it though because interest rates, I mean, they really do touch all parts of our lives, right? From savings rates to student loan rates, credit card rates, mortgages. I mean, it has a big impact on our lives. It's a big topic. It's a huge topic. I mean, it's not surprising that people want to, I think better understand it and also maybe with something that's that important in people's lives, they almost wanna feel like I have more control over it or I have more control over what it's going to be in the future because it is that important in my life. All right, I wanna read a couple headlines. Now, bear with me. These are a little bit longer ones, so I'm gonna read 'em slower here. All right, the first one, stock market melt-up is being fueled by blind belief in lots of rate cuts in 2026. And the other one I wanna highlight, stocks are in turmoil, but treasury yields are stubbornly high. I wanna talk about that one too. You're gonna get on your soapbox for that one. I will get on that one. I do have a lot of soapbox issues. I like the blind belief comment, which actually may be almost the best investment advice ever, which is this sort of like trust or belief in markets. And then maybe don't look at your money too often. So that actually may be great investment advice. Interpretations are important on some of these. Alliteration is really good too. You know, as a fan of literative paper titles, I might have to steal that one. I have to melt up. Interest rates, there seems to be that forever quest and it probably stocks too. But the idea of I gotta forecast interest rates, I gotta predict interest rates as I think about my investment decisions. Wes, how do you think about the ability to predict what rates are gonna do? Well, you can see the appeal of it, right? You know, when it comes to bond math, it's pretty simple that if the interest rate goes up, the price goes down. So that if you could predict when and how interest rates were gonna change, that would be an incredibly compelling proposition for managing your bond allocation. I think what the data tells us is that that prediction is not as easy to get right as it might seem. Well, look at something like the Fed dot plot, right? I mean, there's a just a great example where you have people that are working at the Fed, who are literally in control of setting the rates and yet where the dot plot is over the short, the intermediary or the long term gets adjusted constant. They don't even know where rates are gonna be and they're the ones that are setting up. Yeah, the Fed watch tool on the CME groups website, I don't if you guys play around with it, probably not you, you're working on your golf game doing fun things. But you know, I like to- Lower handicap. I like to look on the internet sometimes at data like this and it uses those kind of data observations to kind of pull together what is the aggregated expectation for, you know, what the Fed is gonna do in the future. And it gives you an estimate, which for this year, you know, by the end of the year, the expectation is that the federal funds rate is gonna go down to a range of 375 to 400 basis points, but the actual likelihood of that is relatively low probability, you know, less than 50% and the stuff around it, the other outcomes still have a pretty meaningful probability around them. So as you're far away from these kind of events, there's a lot of uncertainty about what could happen with rates. And we should be clear, we're not - Knocking them at all, right? It's just the reality of this is that we don't know what's gonna happen in the future and it would be, it actually, in my opinion, would be relatively wrong of them if they weren't updating their expectations based on new information that's coming in. Well, you highlight some of these different sources you can go to. I mean, everyone's participating in this, so there's a wealth of information that's coming into these prices and expectations in there. And you're right about prices are constantly changing. I think you've got a nice example there of how even within a day or two of the Fed trying to determine what to do with interest rates, things change very quickly. Yeah, I mean one of the things that the Fed has articulated they're sensitive to is the potential for inflation. And so, their decisions around cutting rates can be tied to what they're observing in terms of inflation pressure. So, you know, that data is constantly evolving. And there was a really good example back in February, I think it was February 12th, where there was a CPI report that came in and the interpretation of it was that consumer prices had risen more than the market expected. So what happened to the expectation for future rate cuts? Well, that probability fell, but then over the next couple of days you get additional data points about the economy, about consumer prices. You get the producer prices report, that one was not as high and then you saw the retail activity and it was maybe a little bit lower than what some people had expected. So the net effect of those three events was that the probability of rate cuts actually started to creep back up. So, you know, to your earlier point, which is the reason why this is hard to predict is because you would have to predict everything that's gonna happen in the world, not just what the Fed's response is gonna be to it. And that would require a crystal ball, which I have not yet procured. Well, one of the things that you often hear about is, well, it's obvious rates are gonna go up. Well, if it's obvious to everybody, rates have probably already gone up reflecting that expectation across the market. The other thing I wanna highlight that comment about rates, I'm so glad you hit on that. Is it plural? Yes. Right, and you were just talking about the Fed funds rate, which is one rate, but there's sort of this idea that well, every rate out there somehow has to follow exactly what the Fed does, Right, and the only one they directly control is the federal funds rate. And you know, even if you know there's gonna be a period of time where that rate is changing, you still might not be able to say exactly what's happening to other interest rates because they're driven by the market. So I mean, 2024 is a great example where you had three rate cuts starting in September and going through December. And over that stretch of time, the tenured treasury actually went up, the yield on the tenure treasury actually went up. And so, this is not uncommon by the way, when we look at months where there has been a decrease in the federal funds rate, a third of the time the 10-year treasury yield went up. Mm-hmm. So it's like, even with the benefit of hindsight, if you knew that in advance, you still might not get your call correctly on the bond market. And that's relevant when you're thinking about your portfolio's positioning because there's hundreds of rates out there in the marketplace and it's not just the federal funds rate that's gonna drive the performance of your bond allocation. It's interesting on the, oh, here's what the fed's gonna do and this is what's gonna happen with all rates, right? We have sort of this correlation or I can use it to predict, or I can do all of these things. I mean, ask yourself that, you know, if you could reliably predict what was gonna happen with interest rates, like if you had the secret sauce and I mean, would you tell anybody about it? So when you see a lot of these predictions about like, well, here's what's going to happen with either the fed's fund rate or rates in general, just take a step back and ask a logical question. Does anybody truly have that information? And it's a good point there that we're not being flippant. Right. About that. But it's really a logical comment that if you really had that ability of which there's no evidence anybody does, you wouldn't tell a soul, right? You would just trade on it yourself. So I think it's a really important point to keep in mind. Same thing on equity returns too, stock returns. But what about on the equity side of things? What happens when the Fed changes interest rates? How does that impact stock returns? And Jake, we got some data around that one as well. Yeah, I mean, if you kind of carve it up into sort of three categories of when they hike, when they cut or there's no change at all, and then you look at the monthly returns of the broad stock market in those months, I mean, in all three cases, it's right around 1% or so per month. You know, I mean, a little bit, a little bit higher returns when you get a cut versus a hike, but in general, it's right around 1% or so. And then you ask yourself as an investor, regardless of what's going on with the Fed, regardless of what's going on with rates, would I want a 1% average return per month in my stock portfolio? I'd be like, "Yeah, that's how you capture the long-term return of markets." Of course, we're good. Yeah, I think you're hitting on a key point, which is, you know, when we, and you use the word flippant, which I really like, which is when we talk about this data where we don't see a strong correlation between the returns of different asset categories and things like the federal funds rate changing, it's not because market participants don't care about this or it doesn't impact maybe the future cash flows or certain kinds of businesses. It certainly does to an extent. I think what we're saying is that the market in many cases has already factored this in because in instances like the Fed changing the federal funds rate, they tend to telegraph what they're gonna do. And so, market participants have an opportunity to set prices ahead of the actual event. If I think back to 2022, there was a good example of this where there was a very drastic increase in the federal funds rate on June 15th that year. And what you saw was the commentary around what they tended to do was pretty unambiguous ahead of time. And so, the treasury yield curve moved up days in advance of the June 15th rate increase. And so, on the 15th when they actually changed rates, there was very minimal response from treasury yields. That communication's also increased quite a bit over the years. We had a professor come in, remember last year doing a lot of research around this and just sort of the communication that the Fed has the path they've gone down in the last, I'll say a couple of decades. And it's definitely increased and I think that's to your point there, there's could be more information that's out there in the market. So when the actual decision comes out, a lot of times the market may not be that surprised by it. It could be old news and if it's old news, probably can't trade on it. It's a great point on both those examples of how the market, I'll say collectively. I mean, they're on every word- Mm-hmm. The Fed talks about or looking at any numbers out there, trying to anticipate in and price in, you know, expectations of what rates might be in the future. So let me ask you this, when you mentioned 2022, and that was a year where stocks were down significantly and bonds were down significantly, and you read in the headlines quite often about, well, bonds are great because they're kind of a buffer to your stock portfolio that, hey, when stocks go down, your bonds usually hold up, they're pretty stable. I think on average that's true, but we use that term on average, it's not always the case. I'd just love to get your thoughts, Wes, on kind of how to think about that relationship. I mean, that was certainly an outlier when we look at the historical data that in fact, I think that's the only time where stocks have been nega... The S&P 500 was negative for a year and you know, government bonds were negative. I mean, it was just really across the board. Typically, in years where the S&P is down, those other asset classes have been positive. So you know, when we say that those fixed income asset classes are a good buffer for stocks, that is really based on the averages. 2022 is a good reminder too that, you know, I agree with Wes. I mean, it was definitely now. I think 2022 was a year that surprised a lot of people. People know that stocks can go down. I think on the bond side people were surprised, but one thing to remember is, is that in those instances that it's a loss but it's a loss on paper, right? If you don't have to sell, if you don't need the cash, if you don't need, I mean, it's a rebalancing opportunity potentially from a planning standpoint. And as I think people have realized that we are in a higher rate environment, which means you can potentially get higher returns on your fixed income investment. So it was a shock for people, but I try to remind them that, hey, if you didn't have to sell, it's just a loss on paper. It's a great reminder. I think there's a lot of views out there if I own individual bonds, like you're not losing money on those when rates go up. But the reality is, it has the same impact on bonds in a mutual fund or an ETF. That's a good point. Right? It's good point. Yeah. You only realize that loss if you sell on whether you own directly or within a funder, an ETF. I wanna go back to one of the thing here. Now, this is a little bit of a soapbox for me and I think we should... Well, we know I have a lot of soapboxes. We should just get a little box and slide it out there. Mark keeps like five of them there in the corner. The comment of rates have gone up and I wanna go and connect this to mortgages. And I was talking to somebody last year and they were in their 30s, you know, and they're looking to buy a home and they were saying, man, this is just a crazy market. Like mortgages have never been this high. It was really frustrated about, you know, the cost then of servicing a home there, goes way up there. Now you started chuckling this idea if it's never been this high, and maybe in their experience it hasn't, but you go back to, and you guys are young pups relative to me. But my first house, I think it was eight, 9% was the mortgage rate. And at that time it was, well, that's just what it is. Like there wasn't really an idea, it could go down to two or 3% because it's always kind of been higher in my experience there. Mm-hmm. So I think if you look at the long run data there from the Fed, 30-year mortgages has been somewhere in the high 7%, 7.7%, something like that. With where we are today, there's almost seems to be an expectation when you talk to certain people out there that, well, where the 30 years today, I think the high stake is, it might go back down to three or four. I bring that up to say, be careful if that's what you're expecting to do, that potentially could be a long wait. Yeah, I mean, if we're saying we don't think professional money managers can predict when rates are gonna go down, probably makes sense that home buyers are not gonna be able to predict when these things go down. And in the meantime, you're missing out on just the beautiful opportunity of owning a home and you know, having expensive repairs around the house. But no, it really is wonderful having a home. Yeah, it's an interesting one. I mean, you do hear that out be like, well, when rates come down, when rates come down. And look, rates are probably going to move, right? We know that they move around for many different factors, not just the Fed, we've already unpacked that, but you know, maybe four or 5% for the 10 years where it'll be for a long time. We don't know. Now, next year it could be at 2.5 or 3%, it could be at 7%. I don't have a clue what's going to happen, but the idea somehow that they have to come down, be careful going down that path and... All right, we alluded a little bit to a joke about a low handicap. Jake, bring that back up there. I am gonna use it as a way to summarize the conversation today, which is, listen, a couple key points. Can you time or predict interest rates? No evidence you can go do that consistently at all. Not all rates move together, be careful which rate you're talking about there. But then a lot of anxiety comes into when you're trying to do those things and play that game and just walk us through this low handicap strategy idea. People look for these economic signals that give them some indication on what's gonna happen in the future, what's gonna happen with the market and what I'm supposed to do with my money. And when you really start to dive into all of that, you could drive yourself crazy because one, we've unpacked that there's really no direct correlation of X happens and then Y, but when you do that, you spend so much time, so much anxiety, and what I brought up on the last one was is is that it's a high handicap strategy, meaning you have no time to spend on the golf course, so you're horrible at it, right? But you can extend it well beyond that, which is what do you have control over? What do you wanna focus on? And I think for a lot of investors when they get over that hump of, I actually don't have to predict, I don't have to analyze all these variables, I don't have to do all of that stuff to have a great investment experience. It's actually really liberating. Frees you up to do what you want to in your life. Great summary. Someday I'll get a lower handicap. It'll never be low. I wouldn't bet on it. It could be lower. You've seen my golf game. All right, I wanna highlight a couple resources here. Wes, is some of the things that you mentioned earlier. Just make sure you will can go down and see these in our show notes. So here's a couple of the pieces Wes mentioned. Here's a great title by the way, "Fed Forecasting Futility." You like that alliteration? That's a great one. And then the second one, "Don't Get Fed Up, Part 2." So go down, look for those links in the show notes. And with that, a future hot topic we're reading about in the headlines is markets at all-time highs. Be sure to subscribe and enable notifications and have a fantastic rest of the day. Thanks for joining.