For most of the 2000’s, to varying degrees, the Federal Reserve has actively pushed interest rates down in the U.S. economy. These policies always started off as a response to some crisis at the time. Whether it be the tech bubble bursting, 9/11, the financial crisis or COVID, there was always a good reason. But the tools they frequently used were far longer lasting than the original event. The result has been two decades of historically low rates, and these rates directly affected the yield investors were able to get in the bond market – a market which most retirees heavily rely on.
A suspicious person may conclude that keeping these cheap-money policies in place for too long was intentional as it kept the cost of servicing the debt manageable to government even as they tripled the outstanding debt. One could argue that these policies left in place for too long actually led to further instability by creating bubbles in various sectors of the economy, such as soaring housing prices, explosion in the amount of outstanding debt and inflation. One thing is for sure, savers have been on the losing side of this for years. In 2020, a typical retiree needed at least twice the savings to retire on compared to twenty years earlier.
This may finally be changing. In response to the forty-year high inflation rates seen over the last couple of years, the Fed has been forced to reverse course and let rates rise. It has been easy for them to look past many of the warning signs in the past, but inflation this high is something everyone feels and can’t be ignored.
Inflation is loosely defined as too much money chasing too few goods. A little inflation is a good thing and is a sign of a growing economy. When inflation spikes, it is usually because of higher demand for things like oil or housing. The latest price increases have been driven by supply disruptions and a massive increase in the money supply. So, we’ve been getting it on both ends of the equation. The supply problems are a holdover from global COVID lockdowns and will naturally work themselves out, but the money supply issue is a much thornier problem. The massive deficit spending in this country has been paid for by printing new dollars. The money supply has risen from 16 trillion dollars to just under 22 trillion dollars since the beginning of 2020. Increasing the world’s largest currency by a third is an amazing statistic and highly problematic.
This is not going to be easy or quick to work out. It’s for these reasons that interest rates have increased so much in such a short period of time. For perspective, at the beginning of 2022, the 10-year treasury note yielded 1.63%. It peaked in October at 4.25%. The 5-year treasury note yielded 1.37% at the beginning of the year and topped out at 4.45% in October. One of the bubbles cheap money has created is in the stock market. These higher rates are almost entirely responsible for the decline in stocks in 2022.
So, while the financial news was fixated on the selloff in the stock market last year, quietly behind the scenes, yields on income producing investments steadily rose. The greater ability of investors to generate income is finally giving relief to retirees and others that depend on cash flow. This is not a minor point. A year ago, the yield on a typical, investment grade corporate bond was less than 2%. In 2022 we were able to invest as high as 6%.
One thing that is interesting about the improved environment for this particular group of investors is that it’s not always obvious what’s going on. Unlike stock prices that are printed on a statement every month, rising income levels are not easily seen. This is why it is so important to keep the proper perspective on what really matters in your specific situation. Presumably, a retiree has amassed most of their needed wealth by the time they quit working. The actual value of their portfolio in the short term isn’t as critical as the income it provides to pay the bills with. Also, unlike stocks, holding a bond to maturity means you receive some amount of income (usually fixed) while you own it and are paid back a set amount when it matures or is called. The price along the way is meaningless.