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Where will the interest rate roulette ball fall?

Posted by admin on July 12, 2010 in Investment Information

Not so long ago, most of us were worried that governments printing money freely would trigger inflation. Now, with there are fears of deflation- the decrease in the price of goods- due to slower than expected demand by the consumer. This has left many of us wondering where interest rates will head in the short-term. Even though the interest rate set by the Federal Reserve in the U.S. and the Bank of Canada are nearly zero, the deflationary supporters point to Japan as an example of a country where large government deficits, which typically triggers inflation and rising interest rates, can occur along side a low interest rate environment.

If it already wasn’t apparent before, the average household is being bounced about by the larger marco-economic trends occurring in the global economy. Rather than try to predict where interest rates will go, three practical measures comes to mind.

The first pay off debt and deleverage the household. At the household level, part of the fundamental issue is not the unpredictability of interest rates short-term but the ability of some households to weather any adverse economic change whether in the increase in the price of goods or a general downturn in the economy. Paying off debt and deleveraging the household will at least give people more options and breathing space no matter which way interest rates or the economy goes.

Related to the first point, the second is to reinforce the general investing principle of not being fully invested. Fully invested refers to having all available funds invested into products other than short-term cash or cash equivalents/GIC/high interest accounts. Only the most optimistic of investors are fully invested and, even then, it limits options in the event bargains do appears. To be clear, this is not to support ditching investing strategies due to short-term trends but to keep enough in cash to mitigate against short-term losses in your strategy or having resources to make adjustments to your strategy accordingly.

Finally, the general consensus regardless of an inflationary or deflationary outcome is to stay short-term in fixed income products. The rationale for this is the same as the above two: staying flexible and preserving wealth is more important the guessing where long-term interest rates will go and being on the wrong side of the prediction.