THE BIG STORY

Predicting Future Interest Rates

You don’t need a magic 8-ball to see what interest rates will be in the future

In past finance articles we discussed the rise of interest rates and their impact on housing and beyond. Knowing if interest rates are going up or down is of great interest to all sorts of customers, investors, and consumers. Not surprisingly, it consumes a great deal of energy and attention. 

Is there any way to tell beforehand what’s likely to happen with interest rates? Nothing’s foolproof, but looking at where investors on Wall Street are betting their money can help indicate likely outcomes. This discussion may seem a bit nuanced but there are practical ways we can use this information to help make better financial decisions. 

Among other factors, interest rates weigh on the valuation of stocks. In the most simple interpretation, higher interest rates negatively effect stock prices with the inverse also being true. This is largely based on the discounted cash flow formula which is used as a way to price stocks. In this formula a company's future cash flows are divided by a discount rate that is built in part by using the fed funds rate — the one the Federal Reserve has raised recently. It’s basic math: if the denominator grows larger while the numerator stays the same the end solution is a smaller number. Now Wall Street pros do math the same way as anyone else, including the guy in your platoon who loses his NVGs in the field. But what they can do is make different assumptions to the pricing model and then invest accordingly. Often we see the realization of this in financial instruments such as options and futures. 

Futures are financial contracts for a buyer or seller to purchase or sell an asset at a predetermined future date and set price and in essence allow investors to speculate on the future price of said asset. If the future price of the asset turns out to be different from the price in the contract there is money to be made. There are a variety of factors why futures are used by Wall Street but the benefit to us is that they are used in large enough quantities to provide data of what the professionals think the future will be. Yes, Wall Street is often wrong (and occasionally wrong in a big way) but that does not mean we can’t use this information.

Recently, the Wall Street Journal published an article about interest rate cuts. Based on the data from interest rate futures, investors believe there is a 60% chance that interest rates will be lowered by May of 2024. This 60% is up from 29% in October — a pretty impressive difference. 

So what does that mean for the average consumer? I have written before that it may be a better time to rent and wait to purchase a home in the future, but we can also use this sentiment to inform investing decisions. The attractiveness of high-yield savings accounts and Certificates of Deposit or CDs have risen along with interest rates. And while both of these tools may still have a place in your investment portfolio, in the event of interest rates cut they may hold back your performance. High-yield savings accounts still seem a viable option given their liquidity, but CDs, which have an associated time commitment and early withdrawal penalty, could end up providing lower returns than if otherwise invested. At the end of the day, it's not the return you get from one investment, but what else could your money be doing. If you purchase a CD at 5% that matures in one year, what happens if rates are cut during that year and the stock market increases in value. It could be possible that the 5% you earn from the CD is less than what you could have earned in the stock market. Of course there is no one right answer in investing and your portfolio should be determined by your financial goals, time horizon and risk tolerance - but hopefully now you can read the financial news with greater confidence and apply the insights therein to your own financial situation and goals.

TOP READS IN MONEY & FINANCE

Wall Street is betting on interest rate cuts soon.

The expansion of private credit and the phenomenon of direct lending helped propel these former bankers to the forefront of a new take on an old industry that threatens one of the mainstays of Wall Street.

If you’ve been to McDonald’s in the last 6 months, you know their burgers are substantially different (better) from those of the past. This is part of a deliberate campaign to improve its market standing — and the strategy seems to be paying off.

Four deductions that seniors can overlook come tax time.

TOP READS IN THE MILITARY & FOR VETERANS

Lockheed Martin’s Skunk Works is one of the most famous airplane builders in the world, and to commemorate its 80th anniversary, it made a video.

Navy released a video of the P-8A airplane that’s sitting on a reef in Hawaii bay. Not a bad place to be for a person, pretty bad place for a plane.

The family of a soldier who died from cancer at 26 is suing the Army for not diagnosing or treating her properly.

Howard University showcasing the advantages inherent in just lining up full time personnel in finance to work on veterans issues such as the GI Bill beforehand instead of waiting until a big problem comes up.

TOP READS AROUND THE WORLD

President Milei has triggered his first substantial move: a withdrawal from China’s “BRICS” economic coalition, which had previously and proudly touted the addition of the South American country to its ranks.

Henry Kissinger, dead at 100. My personal feeling is that his approach to foreign policy was not suitable for the United States of America although it was influential; he was unquestionably a brilliant thinker and strategist, but too pessimistic and not sufficiently idealistic for our unique system. More suitable to European politics. He’ll be remembered for decades or perhaps even centuries.

The Russia of the past was able to sustain huge losses in conquering territory; this model fell apart during WWI when Russia collapsed into revolution. How long can it sustain heavy losses in Ukraine?

HUMOR

Throwback Google doodle reminds viewers of a time when Google search produced useful results.