Of interest rates and inversions

The media frequently broadcasts unsettling stories about interest rates or about poorly understood economic concepts like the inverted yield curve. Most of those stories gloss over the issues, with a series of talking heads predicting great calamities, until the next heavily hyped topic distracts everyone’s attention.

 

Just as it’s considered wise for the average investor to ignore short-term fluctuations and instead concentrate on long-term performance, as a business owner, you may want to take these alarming stories with more than a grain of salt.

 

The inverted yield curve has received plenty of attention in recent years, primarily as observers try to determine when the current economic expansion — among the nation’s longest-lasting — will come to an end. A yield curve provides an illustration of how the government borrows money to meet short- and longer-term needs using Treasury securities. Usually, longer-term borrowing carries a higher interest rate, but there are times when market conditions make short-term borrowing more costly.

 

That’s what’s known as an inverted curve, and some people suggest it’s a foolproof signal that a recession is imminent. History says otherwise. While it’s true that most recessions are preceded by at least some periods of inversions, those inversions don’t always lead to recessions. The Economist magazine recently cited an analysis of 95 recessions in 16 first-world countries, noting that the inverted yield curve was not a reliable predictor. 1 While the indicator generally has been more accurate in the U.S., 63 inversions failed to stop economic growth. 2

 

Fluctuations in interest rates also get outsized attention. As you know, the Federal Reserve Bank attempts to manage the economy by controlling the Federal Funds rate, the interest rate banks pay to borrow money. If the Fed is worried about the prospect of inflation, it raises the rate, and if the economy seems to be slowing, it typically lowers the rate. The idea behind lowering the rate is to reduce the cost of borrowing, so individuals and companies are more likely to spend money. 3

 

Interest rates charged to businesses and consumers frequently follow the trend created by Fed decisions, but there’s usually less fluctuation. And while the news media may become hyperactive when the Fed changes the rate by 25 basis points (0.25%), such smaller changes rarely have a direct effect on business or on consumer borrowing. They may signal a trend, but changes are less immediate. If money costs lenders more to obtain, they’ll increase interest rates on the money they lend. 4

 

What does all this mean to you as a business owner? In the near term, interest rate fluctuations and flipping yield curves should have limited impacts on the way you do business. If you’ve structured your business to capitalize on healthy economic times and cushion against downturns, you should be fine. If you need to raise capital to pursue business opportunities that will foster long-term growth, don’t worry about trying to outguess the interest rate market. Instead, focus on keeping your business financially strong and work with a lender that’s interested in your long-term success.

 

REFERENCES:

1  “Yield curves help predict economic growth across the rich world,” The Economist, July 27, 2019.

2 “Recession can’t be predicted by single indicator,” Indianapolis Business Journal, August 23, 2019.

3 “What Just Happened Also Occurred Before the Last 7 U.S. Recessions. Reason To Worry?,” npr.com, June 30, 2019

4 “How Interest Rates Affect the U.S. Markets,” investopedia.com, July 31, 2019.

 

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