The return to easy money, and how interest rates will continue to be an inescapable phrase in the coming year.
There was a time that the words “Interest rates” were reserved for economics classes, discussions with mortgage brokers, or the backbone of your drunk uncle’s argument at the Thanksgiving table. But the like most charts from 2020-2021, common use of these two words are up and to the right in a fashion that would make “Who is Travis Kelce” searches on google turn red in the face. And for good reason, interest rate decisions impact close to 100% of American households on close to 100% of the days in a year. It’s fun(??) stuff. Recently, Roge Karma wrote a great piece in The Atlantic, The Era of Easy Money is Over, and That's a Good Thing (https://www.theatlantic.com/ideas/archive/2023/12/higher-interest-rates-fed-economy/676282/). The article argues that “easy money”, (read: low rates) era is over, we should expect a return to 4-5% interest rates, and that is a good thing in the long term. In the next few minutes, I’ll summarize the article and present my thoughts as to why Roge is correct on what we probably should do, and share what I think that means for you.
What is "Easy Money"?
Before we dive in, perhaps a good place to start is what is “easy money”? And why do I care? Good question, my smart, passionate, and beautiful reader. Easy money refers to a time in which the US Federal bank lowered rates to zero in what was effectively called the ZIRP era (Zero Interest Rate Policy, this will be important later), in an effort to stimulate the economy. The intent was to make borrowing easier so that job creators can create jobs, create paychecks, and keep our economy moving. Taking a quick trip back to the late 2000’s, a mortgage lending crisis turned global financial crash caused US unemployment rates to peak above 9%. With so many Americans out of a job, and US companies tightening the belt, things were not great at home. The Obama administration had few options, but one clear goal. They needed to get people spending again. And with a Republican controlled congress, more spending was simply not going to fly.
ZIRP has entered the chat.
I told you ZIRP would be important. The government’s hypothesis was simple. Among other things, make borrowing easier to spur investment, development, remodeling- you name it. If we could incentivize investors to move their money away from safe government bonds (now not producing a reasonable return), into assets like real estate, stocks, etc, we will inflate the value of these assets- resulting in asset owners spending their newfound gains, creating new jobs, new spending, and all will be well. And it worked. The US avoided a financial meltdown, an apocalypse, and we are all better for it. On the back of a favorable investing environment (ZIRP, wow- a second reference??), from 2009 to 2019 the stock market tripled, home values (the largest asset owned by most Americans) soared, consumer spending rose, and unemployment fell. All very healthy signs of a functioning economy.
But, something else happened. As we entered what economists called “The Everything Bubble”, we started to lose sight of the underlying fundamentals of a healthy business. Businesses realized they could take on cheap debt (low interest loans) to support their business. This debt was used to conduct share buy-backs, a shareholder favorite- driving the stock price up. But the elevated stock price has little to do with a healthy business. Had the business attracted new customers? Entered a new market? Developed a revolutionary product? Not necessarily. We also started to see the explosion of a brand-new business model. With wealthy investors realizing enormous returns via a 10-year bull run, venture capitalists were able to fund unprofitable businesses to the tune of billions of dollars. A prime example of these organizations is WeWork, which filed for bankruptcy protection earlier this year. These businesses had not been profitable, were not really even forecasting to be profitable, but rather aimed on “growth”- the promise that invested dollars would lead to more customers and eventually, the business would be profitable. In the era of “Easy money”, these organizations could always go out to private markets and raise more money to pay their bills.
The Party Had to End
For asset-owning Americans, things were great. Investments across the board were doing well, unemployment was low, and the vibe was great. And then a dude ate a bat, a virus leaked from a lab, I don’t know, go ask your cable news uncle. We’ll skip over the next few years of chaos and get to inflation.
With inflation peaking at 9.1% in June of 2022, the Federal Bank did the only thing it could do. In the same way low rates spur investment (demand), high rates bring it to a crawl. The math is simple, if the borrowing costs necessary to take on a construction project, fund a business, remodel the house are high, there are less projects, businesses, or investments that make financial sense. Over the next 18 months, demand slowed. Capital that would previously have been invested “sat on the sidelines” (meaning: was parked in cash or savings accounts) until conditions were better. As rates climbed from 0.25% in March of ’22 to 5.5% in July of ’23, anyone looking at their 401k will tell you it’s been painful.
Now, with inflation right about in line with normal expectations, we seem poised to return to a more normal rate environment.
What Will We Do?
Roge reminds us that while 5.5% is high, we shouldn’t forget that 0% is low. And Roge is correct. Historically, the Fed has set rates around 4%. Roge argues that a return to “normal” is exactly what the doctor ordered. A return to reasonable interest rates is a return to business fundamentals, where the underlying health of an organization drives the stock price, not speculative investing. I started this article on December 12th and had planned to write my dissenting view in “Higher for Longer”, the notion that rates would hang around their current levels for the foreseeable future, at least well into 2024 before rates begin to be cut in 2025. My argument was twofold. One, inflation has been largely tamed. Two, man the current administration could use some good news in the polls. With bad numbers, and an election in 10 months, being able to boast strong economy numbers would really help the Biden administration. Remember, there’s $5T (big T for Trillion) of investor funds sitting on the sidelines waiting for better market conditions. With a favorable market, this rocket ship is ready to blast off. As polls keep slipping, that big green button gets harder to avoid.
And then on Friday, 12/15, the Fed signaled rate cuts in 2024. 3, to be exact. What happened next, the market rallied. The lesson? I’ve got to be faster putting these blogs out. For the haters that don’t believe me, I’ve got the receipts. I’ll share them, but then you’ve gotta share the blog with a friend. Seems like a good deal to me.
Alas, a new takeaway is needed. I’ll give you the second argument I was going to make. Again, it’s pretty simple. That $5T is coming off the sidelines. Investors don’t like keeping cash. And as great as a 5% return in high yield savings accounts are, that aint it, chief. Remember, we’ve been conditioned to a bull run environment. The price of our home will surely go up, investing in the S&P is a can't miss investment, right? This lull, while needed, will end. And the folks with their fingers on the button have lifted the emergency glass and told you they’re going to push it.
What I’m bullish on in the coming year: Real Estate, Crypto, and perhaps more generically- equity markets.
And like that, I’ve reached the end of my 5-minute read promise to you. In a future blog, I’ll deep dive into my case for each of the three projections. Until then, I’d love to hear what you think. Where do we agree? Where do we disagree? What are you having for dinner? Where do you see rates, and subsequently, where are you investing the in the coming months?
Talk soon,
Peter George