Making Sense of Lower Interest Rates Being Good for People and Businesses
All this talk of interest rates may seem in the weeds, but there is a very real connection from everyday people, to main street, to wall street. As an example, think about a big home improvement project that you or a neighbor put on the backburner in 2023. Stabilized construction materials costs and lower interest rates may eventually combine to make the delayed project a future reality. On its face, the $10,000 cost of building materials and thousands more in labor still may be too much money for a person to pay immediately, but special financing offers from the likes of Home Depot or Lowes could make the project possible. 2022 and 2023’s interest rate hikes caused a lot of attractive financing offers to go away because the cost to homeowners rose above their pain threshold. If and when rates fall, financing options like home equity lines of credit or special financing deals from retailers may get sweetened enough that these projects no longer feel as out of reach financially for people.
Standing back from the single home improvement example above, think about that single scenario playing out tens of thousands of times over the course of a year for a single company’s customers. These substantial purchases at publicly traded companies like Home Depot increase their revenue and hopefully flow to the bottom line as more profit for the company. When a publicly traded company is more profitable, they can pay out more dividends and initiate stock buybacks as an attempt to increase their share price. That company could also invest in themselves with capital projects to build more stores or improve their internal processes through technology and supply chain improvements. In short, increasing commerce in parts of the economy sensitive to interest rates empowers businesses to make financial decisions that may make their offerings more attractive to customers, and subsequently reward their shareholders if the decisions lead to more profitability.
Expanding the example of home improvement to businesses of other stripes, a reduction in interest rates gives larger corporations flexibility as well. They have the ability to invest in themselves at more project breakeven friendly interest rates, which makes taking on debt more realistic. When a business opens a revolving line of credit to manage inventory and tools/property, even a 1% decrease in borrowing costs annually would be a boon to their bottom line, as the savings can be substantial. For a firm that borrows $100 million dollars, that 1% APR decrease would amount to $1 million lower interest expense annually. Whether they deploy that savings internally for more employees, more capital projects, or externally as dividends/share buybacks… that business is materially better off because they would be paying less for borrowing money.
You probably have a business in your mind’s eye that you applied the above examples to, but now expand that mental image to the thousands of other publicly traded companies in the United States. The Federal Reserve’s ability to reduce interest rates now that inflation is under control is a boon to business all the way from our home improvement example, to technology, to large manufacturers, and beyond. With a bit of luck from a soft landing here in the U.S., and stability in other economies around the world, we believe that 2024 can be a year that helps Ansardi Group clients progress towards their own financial planning and investment goals.
What Does This Mean for My CD’s, Bonds, and Stocks?
The above commentary on how lower interest rates help individuals and businesses neglects the investment side of interest rates, but fear not, we will briefly address that here. On certificates of deposit, or “CD’s” as they are commonly known, future renewal rates are likely to be lower. Banks are motivated to offer interest rates only as high as necessary to gain new deposits. We already began to see the impacts in December of last year (2023) as banks began pulling back on rates offered for brokered CD deposits. As the overnight Federal Funds Rate gets more likely to be cut, renewal rates on CD’s will likely fall. However, if you already own a CD, your rate is locked in until the stated maturity date on that specific CD.
Bonds operate in a different way to CD’s as they typically are issued with much longer dates to maturity, measured in many years rather than months. Historically, as interest rates fall, the value of existing bond investments tends to go up in the open market. For the sake of brevity, I won’t go deeply into the mechanics of how this pricing works, but have provided a hyperlink to an article on the inverse relation between interest rates and bonds.
Stocks are far more of a toss-up in terms of how interest rates impact their value. The cost of borrowing/financing only goes so far, as the underlying strength of a company’s services and products, and ability to profit from them tend to trump other considerations. So many other things can change about a company, the economy, or the company’s strength in a specific marketplace. All other considerations aside, lower interest rates can be considered helpful to a company, but far from the main factor in many companies’ prospects for success. |
