Looking for Reliable Interest Rate Predictions

A colleague recently asked me if I knew of a good source for reliable interest rate predictions. He was trying to decide whether to break his mortgage and pay the interest rate differential. He only wanted to do this if interest rates were headed back up and it made sense to lock in today’s low rates.

As is often the case, I knew the correct but unhelpful answer. Nobody knows for certain what will happen to interest rates. Even the U.S. Federal Reserve and the Bank of Canada can’t say what will happen to interest rates with any useful accuracy. These organizations react to world events more than they control them.

The yield curve gives the collective interest rate predictions of the financial markets, but rates could be higher or lower than predicted levels. We need to stop looking for financial prophets and make financial choices assuming a range of possible outcomes.

The curious thing about this line of reasoning is that I’ve had people agree with it and then proceed to explain what they think would happen with interest rates. Humans seem to be wired to make predictions even when we have no idea what will happen.

Comments

  1. PatrickMarch 21, 2011 at 7:33 AM

    It seems to me the bank's best prediction of future interest rates would be reflected by the difference between fixed and variable mortgage rates they're offering. In a rational market, this differential must be composed of (1) the difference between the current rates and future rates, plus (2) a premium to reflect the shifting of risk to the bank.

    If someone were to ask me that question, I'd tell them they'll never find a source of interest rate predictions that's superior to the one the bank already used when they set their rates.

    ReplyDelete
  2. Michael JamesMarch 21, 2011 at 10:24 AM

    @Patrick: Of course, these bank rates are driven by the financial markets. But the banks are good at interpreting the market signals for their own purposes and are a good place for the average person to look for interest rate predictions. It's important to remember that there "predictions" are really just a level based on a balance of probabilities. A range of rates are possible and the "prediction" is just somewhere near the middle.

    ReplyDelete
  3. RobertMarch 21, 2011 at 2:57 PM

    I think you're right that we need to stop looking for financial prophets. We need to make our decisions based on the facts that we have and the potential risks we can see. I disagree that we need to plan based on a range of outcomes, only because it would be sufficient to plan based on a worst case scenario. Then, if things work out better, the outcome could only be better than expected, not worse.

    An excellent post.

    ReplyDelete
  4. Michael JamesMarch 21, 2011 at 3:09 PM

    @Robert: Thanks for the kind words. I think I know what you mean by planning for the worst case scenario, but if taken literally, I see two problems. The first is deciding on a threshold probability for bad events. There is no sense worrying about money at all if the worst case scenario is that you'll be hit in the head by a meteor soon. The second is that ignoring upside can lead to overly conservative choices. I think it is reasonable to buy a house if you could only afford interest rates up to 20% over the next 5 years, even though it is possible for rates to go above 20%. The upside of the high probability outcome of happily living in your own home for a reasonable mortgage payment compensates for the small probability of ruin.

    ReplyDelete

Post a Comment

Popular posts from this blog

Short Takes: InvestorLine’s HISAs, 24-Hour Trading, and more

I recently moved some cash into BMO InvestorLine’s high-interest savings accounts (HISAs) that are structured as mutual funds.  Their designations are BMT104, BMT109, and BMT114, and they purportedly pay 4.35% annual interest (which they can change whenever they like).  However, the way they report the monthly interest payments is so baffling that I wasn’t able to sort it out in my first 15 minutes of trying.  A further complication is the following text in the HISA description: “The Bank may pay, monthly or quarterly, compensation to your Dealer at an annual rate of up to 0.25% of the daily closing balance in the BMO HISA.”  I couldn’t find any evidence of such a charge, but I haven’t been invested for a full quarter, and I can’t yet say that such a charge isn’t buried somehow in the confusing reporting.  I have more digging to do before I can recommend these HISAs. Here are some short takes and some weekend reading: Preet Banerjee explains the dangers of Robi...
Read more

My Asset Allocation

I’ve resisted discussing my asset allocation for some time, but now is finally the time to describe it and the reasons behind it. I’m not holding it out as a model portfolio; I believe it’s suitable for me and not necessarily anyone else. With that warning, enjoy the discussion and feel free to ask questions or take some pot-shots. The main reason why I haven’t discussed my asset allocation in detail before now is that I don’t want readers to treat it like a model portfolio and follow it blindly. Everyone’s situation is different. The need for variation in asset allocation from one investor to the next usually isn’t huge, but there is no one-size-fits-all portfolio. A secondary reason for keeping my asset allocation to myself is that I can’t be sure I’ll never change it. For example, I recently made the minor change of switching from an ETF of small-cap stocks to an ETF of small-cap value stocks . I don’t have any plans to change my current allocation, but I may think differe...
Read more

Updated Currency Exchange Method at BMO InvestorLine

There is now a more recent update of the method I use for exchanging currency at BMO OnvestorLine . I recently changed the procedure I use to convert large sums between Canadian and U.S. dollars at BMO InvestorLine. The method I use saves a lot of money compared to using the InvestorLine foreign exchange system. The latest change I made eliminated an annoying interest charge that I had to ask to be reversed. Most people don’t realize how expensive it can be to exchange currency. The extra charge banks and brokerages add gets hidden in the exchange rate. To see this extra charge, start by taking a sum in Canadian dollars, say C$10,000, and finding out how many U.S. dollars you can get. Then see what this U.S. amount would get going back to Canadian dollars. Many people might guess they’d get their original C$10,000 back, but they’d be wrong. In a recent test I did at BMO InvestorLine, I’d get back C$9754, for a loss of C$246 in two currency exchanges. That’s $123 per excha...
Read more

Archive

Show more