Approaching Interest Rates & Their Effect on Markets, Mortgages, and More
Investors use futures to bet on the probability of an event happening. For example, market participants express their views on interest rate movements through the Fed Funds futures market.
The 30-Day Fed Funds futures tells us that there is a 55.2% probability that interest rates will fall by 25 to 50 basis points (bps) by the June 2024 Federal Open Market Committee (FOMC) meeting (a week ago, it was measured at a 69% probability).
For simplicity, we will ignore the effects of hedging activity in the Fed funds futures market.
A month ago, the market was pricing in a 24.08% probability that interest rates will stay at current levels — between 5.25 to 5.50% — by the 12th June 2024 FOMC Meeting. As new data is released, markets revise their expectations.
For example, last week we had slightly disappointing Consumer Price Index (CPI) and Producer Price Index (PPI) results, and today, the probability that interest rates will stay at current levels has risen from 24.08% to 44.83%.
Similarly, a month ago, expectations of a 50 bps cut in interest rate by June was at a 19.13% probability, today it is at 4.42%.
As you can see from the example, interest rates have been notoriously difficult to forecast, and markets are changing their expectations of what they will be every single day. Interest rate policies can depend on many factors beyond inflation and the economy that are outside the control of policy makers. Therefore, trying to make investment or financial decisions based on the forecast of interest rates is a fool’s errand, as it is almost inherently impossible to predict with any practical level of accuracy.
We have written extensively on interest rates and stock returns, here are some examples of our recent writings including but not limited to:
When it comes to interest rates and your mortgages, it is best to plan according to your cashflow needs. A fixed rate mortgage allows you to lock in a mortgage rate typically for two years, which allows you to have an expectation of your monthly mortgage expense. Whilst a fixed rate does not allow you to capture the savings from falling interest rates, it also does not expose you to the possibility of inflation staying high and suffering from the increased costs of consequently higher interest rates.
Another question is, Should you pay down your mortgage in the face of higher interest rates?
The simple rule is: Pay down any debt that has higher interest rates relative to the expected returns on your investments.
A well diversified portfolio of global securities has historically returned close to 9% p.a.¹
Interest rates have a long way to go before eclipsing the return of stocks.
Most of us would trust an accomplished physician to manage our health. After all, physicians have specialised training, real-world experience and access to tools outside the reach of the general public. Most importantly, they took an oath to prioritize the patient’s health over their own interests.
In the same fashion, GYC espouses the same expertise in markets as good physicians do with health care. In addition, we adapt insights from financial science to develop a financial plan that is built upon a rigorously tested investment philosophy.
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¹Represented by MSCI World Index (net div.) from 1970-1998, MSCI All Country World Index (net div.) from 1999-2/2024. Annualised return of 8.9% from 1/1/1970-29/02/2024 in USD.