The era of near-zero interest rates initiated more than six years ago at the height of the financial crisis has been very, very good to investors. The same can’t be said for savers.
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The major U.S. stock indexes have regained all of their losses incurred in the wake of the 2008 collapse of the housing market and the Dow Jones Industrial and broad S&P 500 indexes have recently topped all-time highs.
Meanwhile, interest rates haven’t moved in over six years. That’s left savings accounts and money market mutual funds to languish and millions of American who live off interest earnings from those accounts, as well as other interest-related investments, struggling to make ends meet.
The good news for savers is that interest rates will probably be moving higher by the end of the year so savers will finally start reaping some rewards for their frugality.
“When rates go up the winners will be people who are savers. The losers will be people who are borrowers,” said Ted Peters, chairman and chief executive of The Bluestone Financial Institutions Fund in Wayne, Pa.
Experts like Peters emphasize that the category of savers is a vast one, including elderly retirees whose money is socked away in various interest-earnings funds and accounts, young couples saving for their first home and even youngsters stashing away after-school job money to save for college.
‘There’s Nothing There’
Peters said the historically low interest rates have led to a “misallocation of resources” that has prompted investors to pump their money into stocks primarily in an effort to “chase yields” because interest-earnings investments are a waste of time.
“If you’re in cash there’s nothing there,” Peters stated.
Indeed, the cost to American savers since the Federal Reserve lowered interest rates to a 0%-0.25% range in December 2008 in an effort to spark lending and spur economic activity has been almost a half-trillion dollars in interest income, according to a recent study by insurance giant Swiss Re.
For that six-year period savers have watched their money stagnate in bank accounts and money market funds that have offered virtually no returns. Consider that in the first quarter of 2015 the average annual percentage yield for a U.S. savings account was 0.09%, which means that a saver who put $1,000 in the bank would earn just 90 cents in interest after 12 months.
Swiss Re refers to the phenomenon of these meager returns as “financial repression.”
“Low interest rates help finance governments’ debt and lower funding costs, as well as support growth. But such policy actions cause financial repression. This comes at a substantial cost for both households and long-term investors such as insurance companies and pension funds,” the firm said in a statement.
The Swiss Re study found that U.S. savers have lost about $470 billion in interest rate income since late 2008. According to Swiss Re’s calculations, financial repression has eased a bit since the peak period in 2011-2012.
Swiss Re said that the longer “such extraordinary and unconventional” monetary policies are kept in place ie., near-zero interest rates , the harder it will be for the Fed to return to normal.
Peters, who spent six years with the Philadelphia Fed, said he expects the central bankers to address those concerns by raising interest rates at their September meeting by 0.25 percentage points and then by another 0.25% in December. The Fed will likely repeat that incremental rate hike strategy in 2016, lifting rates by 0.25% twice more next year, he said.
Higher Borrowing Costs
“It will be incremental,” he said. “The Fed is going to do things in a measured, intelligent way. There won’t be any surprises.”
The flip side of that coin, of course, is that higher interest will mean higher borrowing costs. Mortgage rates will tick higher, a reality that has prompted a huge rush on mortgage application and home loan refinancings in the first quarter of 2015 as borrowers seek to lock into the lower rates while they last.
The average rate for a 30-year mortgage currently stands at 3.8%, according to Bankrate.com, down from 4.3% a year ago. If interest rates rise according to Peters’ projections, mortgage rates will follow suit accordingly.
The cost for buying a car or a boat, or any other big ticket consumer items generally purchased through a loan, will also rise. As will the cost for businesses to borrow for capital improvements and other forms of expansion, which could eventually cut into hiring.
The impact on savers will be a net positive, however, after years of seeing their prudent habits come to naught.