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June 22, 2015

Why Rate Hike Could Be Good For U.S. Consumers

Low interest rates have been a boon for most families. Home affordability is close to a multi-decade high, the stock market has more than tripled since its lows and millions of households have been able to refinance their mortgage loans, which in the process has saved thousands of dollars a year. That said, this prolonged period of ultra low rates has had a downside, particularly for retirees: It has become increasingly difficult to find assets that generate a respectable stream of income.
While rates remain extraordinarily low by historical standards, in the last few months we have witnessed a modest change in the environment. The 10-year U.S. Treasury yields have risen by nearly a full percentage point from the January lows, and short-term rates are starting to climb as well. This has led to more stock market volatility, but there are potential upsides to higher rates.

More income on cash

Since January 2009, the average yield available on a 3-month Treasury Bill has been 0.08 percent. At this rate, an investor would earn approximately $0.80 of interest per year (before taxes) on every $1,000 invested. The collapse in money market rates has led to a corresponding collapse in the income Americans are able to generate on their savings. Personal income from interest was about $1.39 trillion on the eve of the crash. While it has stabilized in recent years, today interest income remains roughly $130 billion below its pre-crisis peak (see chart below). That works out to about $1,050 per year of lost income for every household.

Better valuations for dividend stocks

In their search for yield, investors have bid up dividend stocks to unprecedented levels. For example, in January the U.S. utility sector was trading at a 5 percent premium to the broader market. Prior to 2009, utility companies typically traded at a 25 percent discount. That discount reflected the regulated, slower growth characteristics of the industry. The newfound premium (since reduced), on the other hand, is the result of investors seeking investments that can offer lower volatility and higher yield. In an environment of low rates, that yield becomes even more valuable. However, as rates begin to normalize, valuations on utility stocks, as well as other dividend-paying sectors, are likely to come down—a process already well underway. This should create a better entry point and value proposition for long-term investors.

It is true that higher rates will probably bring about more volatility and dislocation for both stocks and bonds, but we think the impact is unlikely to be severe. Assuming rates are rising because the economy is strengthening and the rise is modest, higher rates should not signal the end of the bull market. And for those focused on income, it will make the search for yield a bit less arduous.
Source: Bloomberg
Courtesy Russ Koesterich, CFA, Chief Investment Strategist for BlackRock. He is a regular contributor to The BlackRock Blog.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of June 2015 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.
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The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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