Income seekers who have either sat in cash for the last six years, or moved into risky assets in search of yield, are increasingly anxious for the Fed to begin raising interest rates in hope of returning to the days where interest earned on bank CDs and money market funds could be used to pay bills.
The expectation of rising rates in the coming months is predicated upon the Fed’s signaling that the bond-buying program known as Quantitative Easing (QE), which has helped keep interest rates artificially low since 2008, will end in October.
As the need for QE dissipates, the improving economy should prompt the Fed to begin raising interest rates, which many expect will then raise the yields on the ultra-safe investments that income seekers had grown accustomed to buying for many decades prior to the financial crisis.
While the Investment Committee agrees that rising interest rates will ultimately benefit income seekers, we strongly believe that these investors are likely a decade or more away from being able to generate any level of acceptable income from these asset classes. Hence, nothing will really change for income generation anytime soon, even if rates were to start rising as early as tomorrow.
Our grim outlook is supported by the chart below, which shows the historical progression of the average interest rate paid in money market funds since 1920 in the U.S.
Source: Bank of America Research
The last time that interest rates were near zero was back during the Great Depression. Back then, rates stayed down at zero for close to sixteen years because the Fed raised interest rates very slowly and methodically for fear of causing the economy to fall back into a depression.
Furthermore, it took over thirty years for interest on cash to reach the long-term average of 3.7%. Given the severity of the Great Recession in 2008, we firmly believe that the Fed will repeat this behavior for fear of moving too fast, thus causing income seekers to endure an even longer period of zero returns on cash.
Simply put, the days of buying these ultra-safe assets to pay the bills are over for the foreseeable future, so the timing of the Fed’s first interest rate hike is almost irrelevant.
Implications for Investors
The good news is that income is out there, and the Investment Committee is finding attractive risk-adjusted income on a regular basis. However, the process of finding opportunities has become far more complex than just a few years ago.
Think about the skillset required to fix a car back in the 1970s versus today. Back then, a wrench could fix most problems in an engine. Today, a car mechanic practically needs a software engineering degree and a high-powered computer to fix even the most basic issues!
The same applies to income generation. The strategies used by risk-averse investors to pay bills a decade ago can no longer work in the complexity of markets today. Investors need expertise in the same way we need help when something breaks in our cars.
The bottom line is that the need for active management has never been higher for those who rely on income from investments to pay bills. If it is not our dedicated investment team here at Global Financial Private Capital, then we implore income seekers to find other professionals who are skilled at generating attractive risk-adjusted income because even if the Fed were to raise rates tomorrow, we are likely a decade or more away from any material change in the rate offered on bank CDs and money market funds.
This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private Capital is an SEC Registered Investment Adviser.
