A significant majority of people, inside and outside the investing community, have the impression that interest rates are going to go up a little bit and then slide back down again shortly. Although no one knows for sure what will happen, I think it’s highly unlikely when looking back at historical patterns.
The near-zero interest rate environment we’ve enjoyed since November 2008 isn’t normal when looking back at the last 95 years (doing so was a bit tricky but I was able to find and combine multiple sources of data to get this time frame, sources below). In fact, the only other time in history we went so long with near-zero interest rates was during and shortly after the Great Depression.
Without getting needlessly technical, the interest rates you see as a consumer are based on the federal funds interest rate. The Federal Reserve adjusts the federal funds rate to keep the economy stable. Today, the Federal Reserve is working to keep the economy stable by lowering inflation, which requires raising the federal funds interest rate. In March 2023, the federal funds target rate is approximately 4.6%. The interest rates you see as a consumer are normally some percentage points above the federal funds interest rate. For example, according to Rocket Mortgage, the benchmark 30-year fixed mortgage APR is 7.1% (as of 3/6/2023), which is approximately 54% higher than the federal funds rate.
The Average Interest Rate
According to 95 years’ worth of data, the average federal funds interest rate is approximately 3.6%. Note, however, that over the last 95 years the fed funds interest rate has varied from near-zero to as high as 19.1% (June 1981).
Where Are We Headed?
Consistent with a lot of my research, I am going to employ the Law of Averages to get an idea of what we should expect going forward, assuming that nature will (eventually) make us regress to the average.
From November 2008 through April 2022 (162 months, or 13.5 years), the average federal funds interest rate was 0.51%. Let’s say we expect that within the next 20 years we’ll catch up back to the average federal funds interest rate of 3.6%. What will the average federal funds interest rate have to be from May 2022 through May 2042? 5.7%. What’s a 30-year fixed mortgage probably going to look like? 8.8%.
But Wait, There’s More…
Note that 5.7% is the average federal funds interest rate we need in order to return to the average. So, how high will interest rates go? This depends how effectively spending habits change in response to rising interest rates. My hunch is that we’ll probably get to around 8%, which means a 30-year fixed mortgage might get to around 12%. And I highly doubt that we’ll be falling below 3.6% again for a long time.
What does this mean for you? This will mean different things to everyone because everyone has a different financial situation, so it’s difficult for me to provide a general conclusion. If you have a financial advisor, you should discuss how you can best weather a likely period of sustained high-interest rates, and be extremely skeptical if your realtor tries to convince you to buy an expensive house today because “you could probably just refinance to a lower rate in a few years.”
Sources: My original research only used data from FRED Fed Funds Effective Rate which only goes back to 1954, which only provides 69 years of data and an average fed funds rate of 4.6% (as opposed to 3.6%, where that 1% makes a significant difference). This kind of research is one of those times when 70 years of data actually isn’t a lot. After some digging around I found additional federal funds rates from The New York Herald-Tribune and The Wall Street Journal which gave me 26 additional years of data. These two sources provided bid and ask prices so I used the midpoints as the effective fed funds rates during that time.
https://fred.stlouisfed.org/series/FEDFUNDS
Historical The Wall Street Journal data: https://fred.stlouisfed.org/graph/?g=wKuX
Historical The New York Herald-Tribune data: https://fred.stlouisfed.org/graph/?g=wKv4
Here’s a really interesting paper I found that thoroughly digs into the history of the federal funds rate and how the system progressed in 1954 to the same system we use today:
Post script: Yes, it’s been a while since I’ve posted; some unexpected life events happened at the end of January that required my attention. I still have a lot of ideas to post about so there will be more to come.
Alex D Hayes 
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