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Interest rates are at historic lows. In many cases, savings account rates and short term certificates of deposit rates are below 1%. Rates for borrowing, such as for long term mortgages are also levels not seen for many decades. What these low rates mean and how to react to them are questions we are all facing.
Putting today's rates into a longer term perspective
Here are two charts that show the interest rate yields on U.S. Treasury securities with maturities of two and ten years. The yields on U.S. Treasury securities are good barometers to use when looking at interest rates because they are the result of a very large supply/demand marketplace. Other interest rates for saving and borrowing tend to reflect them as well.
This first chart begins in 1980 and demonstrates how rates for shorter and longer term U.S. Treasury securities have been trending down over those 34 years. While they are not totally in lockstep in that downward trend, the yields on both have fallen from about 12% to less than 2%. Note that rates have moved up recently, especially with the longer term 10 year maturity.
This chart just represents the last 15 years and notice that while rates on two year and ten year securities have fallen, they have not moved in lockstep. At the beginning of 2002, both had yields of around 6.5%. As of September, 2012, the yield on a ten year maturity security was about 2.75% and a two year security was yielding less than 0.3%. Note that rates have moved up recently, especially with the longer term 10 year maturity.
How this has happened?
The Federal Reserve made several moves after the bombings of 2001 to keep interest rates low to help avoid a recession and similar moves after the financial crisis of 2007/2008. The Federal Reserve has taken additional steps to keep interest rates low through 2016. For investors around the world, U.S. Treasuries continue to be seen as a very low risk investment with many foreign investors continuing to buy large amounts of U.S. debt.
How long will low rates last?
In general, rates have been coming down for over thirty years. Some believe that rates would rise if the economy improved or if the marketplace started to perceive more risk with U.S. Treasuries. Others believe rates will stay low for several years to come. While the Federal Reserve continues to try to keep rates low and foreign investors continue to have high levels of demand for U.S. Treasuries, the real answer is that no one knows for sure.
How should you deal with these low interest rates?
First, recognize that today's rates are very low when viewed in a long term perspective. That is bad news for those wanting interest income, but very good news for borrowers. If you have existing borrowing, now may be a good time to consider refinancing those loans to take advantage of the low rates.
Second, if you are looking for interest income, be cautious. The only ways to earn higher rates are to invest in things that have higher levels of risk or to lockup your funds in vehicles that have longer maturities.
Finally, use common sense. If someone tries to sell you an investment that looks too good to be true, it may very well be a scam to avoid.