Does it really matter when the Federal Reserve begins to raise interest rates?
That question of “when” — and Fed Chair Janet Yellen’s reply — caused a commotion last week. Ms. Yellen, a bit off guard, I suspect, when asked the question of when rates would rise, said the Fed could act as soon as six months after it stops its bond-buying program later this year. Her answer sent everyone into a tizzy, with pundits, economists and analysts all but bumping into each other as they rushed around to revise their estimates … which is one of the reasons punditry, economics and market analysis are so sketchy — no one has any conviction in their beliefs.
See, to me, there is a much — much — bigger question at hand. “When” is mildly irrelevant.The real question we want to know is: To what degree can the Fed afford to raise rates?
That answer offers far greater insight into our future …
It was back in January of 2012 when I told readers of my Sovereign Investor monthly newsletter that we have entered the Decade of Yield and that “dividends will emerge as one of the most crucial forms of income.” That assertion came in response to the Fed’s excessively easy-money policy.
Ever since then, I have been continually counseling my readers to load up on high-quality, high-yielding dividend stocks because interest rates in America will remain subdued out through the end of the decade. As an investor, then, what I want to own are companies like the one I recommended in that January 2012 issue; it has given us more than 19% in dividend income over the last two years — nearly 10% a year. A Singaporean company that’s high on my list still today has given us more than 25% in dividend payments since October of 2011 — again, more than 10% a year.
Such a meaningful level of stable income is crucial to our U.S.-centric portfolios for one reason: Regardless of when the Fed begins to raise rates, the ultimate destination for U.S. interest rates is not very far from where we are today.
Fed governors are painfully aware of the fact that, because of the $17.6 trillion in U.S. debt, interest rates are a bullet aimed at America’s head.
The largest portion of America’s debt is short term, maturing between one and five years. As a country, we are effectively sitting atop the world’s largest adjustable-rate mortgage. And therein lies a vast interest-rate risk for Congress. Our national debt constantly rolls over — as one tranche matures, another takes its place … not such a bad arrangement when interest rates are falling.
But in a world where interest rates are rising because of the Fed’s move to lift those rates, suddenly we have a significant problem. Our government will be rolling over its debt at higher rates — meaning higher costs to keep the lights on in our debt-addled nation.
With Higher Rates, America Would Crumble Like an Upside-Down Homeowner
Right now, the U.S. pays, on average, about 1.97% in annual interest on that $17.6 trillion in national debt. Net interest payments for fiscal 2015, which will begin in October, amount to somewhere in the range of $250 billion, roughly 8% of the federal budget.
Consider what happens, however, if the weighted average interest rate across our collection of Treasury debt rises just 1%: That’s a $176-billion increase in interest payments, 70% more than we’re paying today — and that assumes our debt does not increase, though the last time that happened was 1957. And what happens if the weighted average rate moved back to a historically normal 5% range over the next, say, five years?
Suddenly, America would have to pay nearly $1 trillion a year in interest payments — what would be roughly a third of the U.S. budget. And, again, that — laughably — assumes our debt does not increase over the next five years.
There’s simply no way our country could function in that scenario. America would crumble like an upside-down homeowner during the housing crisis, and I do not believe the Fed will allow that to happen. Fed governors will pursue whatever extraordinary, untested, extreme measures are necessary to keep a ceiling on rates, no matter how distorted the markets become … because the alternative is the collapse of everything you and I know as normal in America.
Thus, I fully expect interest rates in America will remain subdued for years — out to the end of the decade, at least — simply out of desperate necessity. At most, we might — might! — be near 3% by the time 2020 rolls around.
That leaves us few choices as investors and savers seeking income. If you have investible funds sitting in cash right now and you think we’re finally back to a world where you will soon enough find one-year bonds and CDs paying 3% to 5% … well, you have to stop dreaming about a past because that is not in our immediate future. Yellen and her Fed buddies simply can’t allow high rates to arrive until Washington gets it debt addiction under control.
Best you can do is put your cash to work in high-quality, high-yield stocks … and hope we elect smarter people to Congress one day.
Until next time, stay Sovereign …
Jeff D. Opdyke
Editor, Profit Seeker
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