The Psychology of Interest Rates

Dedicated readers of TGIF 2 Minutes will recall highlights two weeks ago of Morgan Housel’s excellent book, The Psychology of Money. Digging deeper into the book revealed the theme that human nature and psychology most often lead people to hear – and believe – only what they want to hear and believe or see happen.

This statement is not an insult or meant to sound arrogant. Rather, in matters of money, financial markets and even the economy there is evidence that people, the more they want something to be true, most often will believe a story that overestimates the odds of the story being true.* The markets, following recent comments by Fed Chairman Jerome Powell, nudged UP on thoughts the Fed might “pivot” (meaning: possibly slow the pace of interest rate increases and even lower interest rates next year – a wishful “story”). But more recent moves down in markets reflect the less popular belief that the US Federal Reserve likely will NOT reverse course, thus continuing to raise interest rates until inflation shows evidence of cooling. 

Of course, the markets and US consumers wish otherwise: investors wish that stocks would go up and that interest rates on mortgages and credit cards would stay low. The “story” we want to be true is that stocks will resume their upward move – NOW. But in order for prices to moderate for most consumer purchases (meaning for consumer prices to stop going up), interest rates need to go up to a level that cools the inflation frenzy. And when interest rates go up, stocks typically go down for a time.

In the “old days”, a mere 15 years ago or so, it was said that moves in interest rates made by the Federal Reserve needed two years to filter through into the economy. These days, market participants and investors expect much faster results, which is not always best. Not that two years needs to be the time frame. But even one year may be a reasonable period needed for stock prices and consumer prices to adjust to 12+ years of major stock gains and near-zero interest rates that fueled much of those stock gains.

Three controllable factors amidst these times are:

  • Asset allocation
  • ample levels of cash savings
  • moderation of spending.

Let these three factors be part of your psychology.

*Housel, Morgan. 2020. The Psychology of Money. Harriman House Ltd. Chapter on “When You’ll Believe Anything”. 

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