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Interest Rates

The good news is that the near future of interest rates is likely to be fairly stable. There may be small changes with interest rates increasing and decreasing slightly but no large changes in either direction are expected. These small oscillations are not a concern for potential home buyers who are looking to purchase a home in the near future. They are likely to be able to lock in an interest rate that is comparable to the current interest rate. While the projected stability of interest rates is good news for those looking to invest in real estate the general population may find that an economic downturn is on the horizon.

If history repeats itself the economy may be headed for a recession and a recent event involving interest rates is one of the factors that has financial analysts predicting an impending recession. On January 26th of this year an inverted yield curve occurred causing many to believe that we were headed for a recession. In the past 30 years every recession has been preceded by an inverted yield curve and as the history of our economy has proven to be one of the strongest indicators of the future of our economy many in the financial world believe that we can begin to see signs of a recession within the next year.

Understanding what exactly an inverted yield curve is can help to provide a better understanding of why the occurrence of an inverted yield curve can be an indication of a forthcoming recession. An inverted yield curve occurs when the short term interest rates are higher than the long term interest rates. Long term interest rates usually are higher than short term interest rates so it is quite unusual for short term interest rates to exceed long term interest rates. The normal situation makes sense because long term loans carry a higher risk than short term loans so a higher interest rate is charged to account for this higher risk.

Under the normal yield curve banks are able to operate profitably. Banks borrow money from those who hold savings accounts with them under a short term loan and pay the account owners interest for this loan. The banks are then able to use that money to issue mortgages and other long term loans at a higher interest rate. By issuing loans that bear higher interest rates than the banks are subject to, the bank is able to profit from the situation where long term loans carry a higher interest rate than short term loans. Under an inverted yield curve it would not make sense for banks to issue long term loans because the interest rate would be lower than the rate they are paying on their short term loan. For this reason, as the difference between short term and long term interest rates becomes smaller, banks are less likely to issue loans because their potential for profitability becomes diminished. The health of our economy depends on keeping money in circulation so when banks become less willing to issue loans there is less spending and as a result the economy can be pushed into a recession.