by Dave Kutcher
We get to hear a diverse range of opinion from folks as part of our work in terms of how they feel about the economy and the impact that may have on their own personal financial goals and objectives. Unfortunately, many of these opinions are formed from headlines they see or hear on local news and in local publications. Rarely is there deeper consideration for the words below the headline nor is there often common sense applied to what is forming those opinions.
A positive job report comes out and everyone takes a deep breath thinking we are on a road to recovery. These are kneejerk reactions without much substantive analysis and can lead people to thinking things are going to be just fine when the real writing on the wall is problematic at best, disastrous perhaps a more fitting description of what may occur over the next few years.
Interest rates play a major role in financial decision making not just for investors making decisions as to where to put their money, but also, more closely, interest rates have a big impact on how companies operate … many using debt to finance their operations, just as families do to finance things such as their home mortgage, car loans, credit cards, etc.
We have all enjoyed a very long period with interest rates at rock bottom levels. Money was cheap. Borrowing cost little for all but the riskiest of borrowers. Things have changed quickly, however, and for those with adjustable rate loans, credit cards, etc. that set their interest rates based upon a multiple of prime lending rates are seeing their monthly payments rise to exorbitant levels and in many cases, levels that are not sustainable with a static household income.
From a personal household view, people are going to be defaulting on credit cards and other loans because they simply can’t afford the monthly payment with the new higher rates being charged on outstanding debt. Those who were seeking to sell their homes are finding prices of homes are falling to reflect the higher cost of borrowing for the buyer. People buy homes based upon what they can afford each month in a mortgage payment … in rising interest rate environment, that obviously tightens the budget and is reflected in what someone can afford to pay.
For companies that rely on financing their operations with debt, aka using bonds, they are borrowing money to pay their bills and build their future. The riskier the borrower, the higher the interest rate that must be paid. You may have heard the term “junk” bonds. Junk bonds refer to high-rate bonds as compared to other bonds such as a US Treasury Bond. Investors take risk investing in the junk bond market because they are betting that taking the extra risk of lending to a higher risk company will yield them a higher rate on their investment.
A day of accountability is coming. Bonds have maturity dates and as current bonds reach maturity, those companies and our own government needing funds will be faced with having to reconcile the higher cost of financing moving forward. For the last 40 years companies and governments have been doing this into a lower and lower rate environment … lulling them into use of cheap money without much concern for what may come when the interest rate environment changes.
While the junk bond market has a little more time in terms of the window to refinance debt, the time is still coming, even if it is few years out in that market. However, the US Treasury is faced with having to refinance more than half of the bonds that are issued over the next three years. Only a short time ago, pre-pandemic, the US interest payments on our national debt was less than a trillion dollars per year. That carrying cost of issuing these US Treasuries is on a straight-line vertical rise. It is going to cost the US astronomically and with spending out of control in Washington, the problem simply gets bigger and bigger.
As businesses that rely on junk bonds to run their companies seek funding in the next few years they will be challenged by the competition of bond investors who can find much more attractive rates than had been available in the past from governments and investment-grade bond issuers. In other words, investors in the bond market may not be willing to bear the risk of the junk bond investment when they can already get a decent return with much less risk.
Here’s our summary for today; don’t be fooled that things are ok economically in the US right now. The reckoning is still to come. You would be smart to do all that you can to pay off adjustable or higher rate loans such as credit cards and car loans. Your carrying costs have increased substantially … get rid of the debt and when that happens then build some cushion to bear the burden of a recessionary economy. It is essential to have emergency funds in place.
We challenge you to think for yourself and be less swayed by election year headlines…things are not going to get easier in the next few years as many economic factors tend to lag. We will pay the price of the last few years in the next several years coming. You don’t want to be in a position of weakness, and if you have extraordinary carrying costs for household debt due to the higher interest rate environment you will find yourself struggling far worse than others who have positioned themselves to take advantage of higher rates as an investor rather than being subject to the higher rates as a borrower. Now it is most important to live within your means.
My name is David A. Kutcher, a retired Marine Corp Captain. My business partner in the lower 48 is Richard C. Scott, CLU, LUTCF. For nearly 40 years we have been helping folks with their personal retirement decisions. We encourage you to make an appointment and get ahead of your concerns as early as is possible. You can catch us on the radio every Saturday morning, “Retirement in the Last Frontier”, 8:30-9:30 on AM 650, Keni Radio. Frontier Retirement, 10928 Eagle River Road; Eagle River, AK 99577, (907) 795-7452.