Physicians' Guide to Wealth

A guide for anyone pursuing financial independence

Q
Weird Wonky Wild Interest Rates

Mar 24, 2022

Proud son moment, yesterday my father is releasing his second book, The Physicians’ Guide to Wealth, with the subtitle being The Doctor’s Guide to Financial Independence. I’ve watched my dad work with people from all walks of life, with many of his clients being doctors. Some of these doctors have known me since I was 12 years old, back when I played baseball for Cupertino American Little League. After a few nudges and a lot of encouragement from friends and family, my dad finally wrote a book dedicated to those he has worked closely with for a long time. I couldn’t be prouder! The secret to his book is that you don’t have to be a doctor to gain a lot of knowledge from it, the chapter on market cycles is worth the price alone in my humble opinion. Buy it for a dollar on kindle and leave a review here.

So, while my dad is busy with his book launch, you are stuck with me to talk about weird wonky wild interest rates. Typically, government bond yields move at a snail's pace, which is why we hardly ever hear about them, but recently they have been acting less than typical. Atypical, even.

While you may be thinking that these yields are nowhere near where inflation rates are, it’s important to note that they are rapidly on the move. The chart below shows how drastic the recent moves in five-year and two-year rates have been.

As you can see and may recall, rates sunk to the floor of what felt like the ocean in 2020. Now that they are coming back to life, it’s interesting to note that the velocity of some maturities are the same and different than others. For example, the two- and five-year treasury has almost the same yield as the 10-year treasury. From a textbook perspective, short-term debt and long-term debt should not be the same, and we don’t anticipate them to hold that way forever.

Narrow spreads, such as what we see now, tend to lead to a flat or inverted yield curve, which indicates a slowing or contracting economy. Wider spreads lead to an upward sloping yield curve, which indicates a growing economy. Said another way, when are as tight as they are now, we’d expect inflation to be low. However, inflation is obviously not low at all, which is why I started this post saying that interest rates are being weird.

Our current economic environment is throwing a wrench in the long-term relationship between yields and inflation rates, just look at the chart below.

As you can see, it’s not normal for the 30-year treasury rate to be below the inflation rate. The last time inflation was this high and higher than the 30-year treasury was in 1980 when my dad was not yet working with doctors on their finances. Certainly, he wasn’t publishing a book about it.

What Does This Mean to Me?

The first is that we shouldn’t expect your savings account interest rate to go up anytime soon. While inflation and yield are up, the Fed only raised interest rates by a quarter of a percent. However, we may actually start to see some income from bonds for the first time in a while. As interest rates go up, bond yields go up, and the price of older bonds with lower yields go down. The longer the duration in bonds, the more sensitive they are to interest rate movements. So far, the change in yields for various bond ETFs have followed that general rule of thumb. The caveat here is that bond yields at 2% while inflation is at 8% is a negative real return.

Another impact of higher rates are higher borrowing rates such as a 30-year fixed mortgage. The trifecta of higher inflation, rates, and borrowing costs is going to impact investor allocations in adverse ways we can’t predict. The debt market is full of short-, mid-, and long-term feedback loops inside a complex adaptive system that is changing at a rapid pace that make it very difficult to forecast future movements. Clearly, we are in a new environment with a different playbook than the previous expansionary period of 2008-2020, and individual investors should take note.

If you would like to discuss your financial goal plan and how your investments can be best positioned to underwrite a meaningful life, we’d love to talk! Have a great week.

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