Normalization in real interest rates. The improving economy is leading to a normalization in real interest rates, which suggests higher rates of return on investment. In fact, to the extent the macro environment continues to improve, I would expect real long-term yields to continue to normalize, a development that in the past has been associated with higher levels of capital spending.
Market Realist – The graph above shows the federal funds rate since November 2004. The rate has been near zero since late 2008. It’s clear that interest rates can’t get any lower, as the near-zero federal funds rate shows. As a reminder, the Fed is currently targeting rates between 0% and 0.25%, but the actual rate varies based on market dynamics.
Usually, interest rates rise when the economy is doing well, which results in higher capital spending.
Near-zero interest rates, coupled with the fact that the economy is recovering, we can deduce that interest rates will head upward soon. This is usually a negative for bonds (BND), especially bonds with longer maturities (TLT)(IEF). However, equities (SPY)(IVV) may have some headway if the economy keeps improving.
The next part of this series explains another reason why spending could improve.